Series 7 Exam Question 54: Answer and Explanation

Question: 54

Mrs. Rice purchased 500 shares of TUV common stock on margin at $30 per share. If TUV is currently trading at $22 per share, how much is the account restricted?

• A. $2,000
• B. $2,500
• C. $4,000
• D. $5,500

Correct Answer: A

Explanation:

A. When securities held in a margin account go the opposite direction of what the investor was anticipating, the account can become restricted. A restricted account just means that the equity (EQ) in the account drops below the Regulation T (Reg T = 50%) requirement. The investor would not be required to deposit any additional money if the account becomes restricted unless the account drops below minimum maintenance. So, to see where Mrs. Rice stands, set up the account as follows:

$\begin{array}{c}\text{ LMV }-\text{ DR }=\text{ EQ}\\ \sout{\text{\$15,000}-\$7,500=\$7,500}\\ \text{\$11,000}-\$7,500=\$3,500\\ (\$11,000\times 50\%)=\underset{¯}{\$5,500}\\ (\$2,000)\text{ restricted}\end{array}$

Initially, Mrs. Rice purchased $15,000 (500 shares at $30) worth of securities on margin, which means that the LMV (Long Market Value) is $15,000. With Reg T at 50%, she had to deposit $7,500 ($15,000 × 50%) to meet the margin call. This means that the equity (EQ) is $7,500. This also means that she had to borrow $7,500 (the DR) from the broker-dealer. Next, the long market value dropped to $11,000 (500 shares × $22 per share). The DR remains the same, so the EQ had to drop to $3,500. Next, multiply the LMV by 50% to see what the EQ should be for Mrs. Rice to be at the 50% margin requirement. To be at 50% of the LMV, Mrs. Rice should have $5,500 in EQ. Since she only has $3,500, the account is restricted by $2,000 ($5,500 - $3,500).