Key Takeaways
- Reg T requires 50% initial margin on securities.
- Limits broker credit for investment purchases.
- Triggers margin calls if equity falls below requirement.
What is Regulation T (Reg T): Definition of Requirement and Example?
Regulation T (Reg T) is a Federal Reserve Board rule that governs the extension of credit by brokers and dealers when customers purchase securities on margin. It sets a 50% initial margin requirement, meaning you must deposit at least half the purchase price in cash or collateral to buy securities on margin.
This regulation stems from the 1913 Federal Reserve Act and aims to control leverage and limit excessive risk in the securities markets.
Key Characteristics
Regulation T establishes essential rules for margin trading. Key points include:
- Initial Margin Requirement: Investors must deposit at least 50% of the purchase price when buying securities on margin.
- Credit Extension Limits: Brokers cannot lend more than 50% of the security’s value for margin purchases.
- Covered Securities: Includes exchange-listed stocks like SPY and corporate bonds, but excludes government securities and penny stocks.
- Settlement Period: Cash or margin calls must be resolved within two business days to avoid forced liquidation.
- Margin Calls: A call is issued when maintenance requirements are not met, requiring additional funds.
How It Works
When you buy a security on margin, Regulation T requires that you initially fund at least 50% of the purchase price in cash or marginable securities. Brokers then lend the remaining amount as a loan secured by the securities purchased.
If the value of your securities falls, your broker may issue a margin call demanding additional funds to maintain the required equity. This ensures compliance with the initial margin threshold and prevents excessive borrowing against declining assets.
Examples and Use Cases
Understanding Regulation T through practical examples can clarify its application in real-world investing.
- Stock Purchases: Buying $10,000 worth of BND requires you to deposit $5,000, with the broker lending the remaining $5,000.
- Margin Calls: If you own shares of SPY purchased on margin and the price drops significantly, your broker will issue a margin call to restore the 50% equity requirement.
- Broker Selection: Choosing from best commission-free brokers can provide margin account options that comply with Regulation T while minimizing trading costs.
- Sector Examples: Companies like SPY represent marginable securities eligible under Regulation T rules, unlike some restricted asset types.
Important Considerations
Regulation T enforces strict initial margin rules, but it does not govern maintenance margin requirements, which vary by brokerage. You must be prepared to meet margin calls promptly to avoid liquidation of your positions.
Also, Regulation T’s 50% margin limit applies only to initial purchases; subsequent trading and portfolio adjustments may be subject to different rules or margin maintenance levels. Always review your broker’s margin policies and understand risks before trading on margin.
Final Words
Regulation T sets a clear 50% initial margin requirement, limiting how much you can borrow when buying securities on margin. To manage risk effectively, review your brokerage’s margin policies and calculate your available cash before making leveraged investments.
Frequently Asked Questions
Regulation T is a Federal Reserve Board rule that governs the purchase of securities on margin by setting a 50% initial margin requirement. It limits the amount of credit brokers and dealers can extend to investors for buying securities, helping to control leverage and reduce excessive risk.
The 50% initial margin requirement means investors must deposit at least half of the purchase price of a marginable security in cash. For example, if you want to buy $10,000 worth of stock, you must put up $5,000 and can borrow the remaining $5,000 on margin.
Regulation T applies to exchange-listed stocks, corporate bonds, certain mutual funds after 30 days, and some convertible bonds and stock options. It excludes government securities, municipal bonds, penny stocks, IPO shares, commodities, and futures.
If an investor wants to buy $10,000 in marginable stock, Regulation T requires at least $5,000 in cash or special memorandum account funds. If the account lacks sufficient funds, the broker issues a Regulation T call that must be met within two business days.
If the stock price falls, reducing the portfolio value, the allowed margin loan decreases accordingly. For instance, if the value drops from $1,000 to $600 while borrowing $500, the investor may face a margin call to deposit funds to meet the new 50% requirement.
A Regulation T call happens when an investor’s margin account does not meet the 50% initial margin requirement. The investor must deposit additional funds or securities within two business days to comply with the rule.
If an investor fails to meet a Regulation T margin call, the broker can liquidate securities in the account to cover the deficiency. This enforcement helps maintain the required margin level and limits the broker's risk.
