Memorandum account

Memorandum account, also called special memorandum account (SMA) or special miscellaneous account, is an account that contains official customer's records. Even though an SMA is a separate account, it works in conjunction with the customer's margin account. The reason for creating the memorandum account is the fluctuation of securities values on a margin account. As a result, any equity excess can disappear rapidly. To avoid this situation, the broker, after disclosing that the excess equity exists, usually transfers excess equity amount from the margin account to the memorandum account. This activity prevents unwanted security values changings. In other words, the SMA is used to maintain security in its original or existing state and preserve customer's buying power .

Memorandum account characteristics

Since the memorandum account is related to the customer, it will usually contain the name of relevant customer, date, amount and explanation of any entry. The memorandum account may have zero balance or credit balance which represents funds available related to the relevant customer and the amount held on this account may be used for purchasing new commitments or can be withdrawn . The Memorandum account may contain the entries such a :

• dividend and interest payments,
• precedes of a sell of securities, cash related to liquidation or expired security which is no more required and can be withdrawn,
• transfers from margin account,
• other cash no longer required.

Memorandum account example

Weiss D. explained the memorandum account by the following example : "Amy Strate bought 1,000 shares of PUP at $30. The stock rose to $40, giving Amy $5,000 excess. Amy could have used the excess to acquire $10,000 worth ZIP, but if she didn't? The $5,000 would be stored in the SMA. The $5,000 would remain in Amy's SMA until she used it. The account's condition at any given time would be the determining factor. As Amy used the SMA, the debit balance in her account would increase. Therefore, if her SMA grew toa huge balance, or if the market value fell, she could only use that portion of the SMA that would not trigger a margin call for more collateral."

Advantages of Memorandum account

Memorandum accounts offer several advantages. Firstly,*they provide customers with more flexibility when purchasing securities, as customers have a larger buying power. Secondly,*they help customers protect their securities from rapid fluctuations in value. Thirdly,*they allow customers to manage their accounts more efficiently, as they can easily transfer excess equity to the SMA. Lastly,*memorandum accounts help brokers monitor their customers' accounts and ensure that their customers are not taking on too much risk.

Limitations of Memorandum account

The memorandum account has several limitations. These include:

• The account is not insured by the Federal Deposit Insurance Corporation (FDIC). This means that if the broker or institution holding the account goes bankrupt, the customer may not receive the full amount of their funds.
• The account cannot be used to make purchases or withdrawals. As such, it cannot be used as a primary checking or savings account.
• The account is not eligible for interest payments. This means that any funds held in the account will not accrue any interest.
• The account is not accessible for online banking. This makes it difficult for customers to view their balance or transfer funds in and out of the account.
• The account is subject to the rules and regulations of the broker or institution that is holding the account. This means that customers may be limited in the types of activities they can engage in with the account.

Other approaches related to Memorandum account

The following list includes some of these approaches:

• Margin account: Margin accounts are used to purchase securities on credit. Brokers use margin accounts to ensure that the customer’s funds are secure and their assets are not subject to market volatility.
• Cash account: A cash account is a type of account that requires customers to pay for the purchase of securities in full. Cash accounts are beneficial for those who do not wish to take on the risk of trading on margin and want to benefit from the increased security of not having to rely on borrowed money.
• Sweep accounts: Sweep accounts are a type of account that allows customers to transfer funds from their margin accounts to a sweep account in order to avoid the possibility of having their assets wiped out in case of market volatility.
• Options accounts: Options accounts are used by traders who wish to buy or sell options contracts. These accounts are beneficial for those who want to profit from market volatility without taking on the risk of trading on margin.

In summary, there are various approaches related to Memorandum account, such as margin accounts, cash accounts, sweep accounts and options accounts, that brokers use to manage customer's funds and maintain buying power.

Footnotes

Memorandum account — recommended articles

Initial deposit — Distribution In Kind — Pledged asset — Void Transaction — Credit instrument — Allotment letter — Cash bond — Collateral management — Redeemable shares

References

• Boston Institute of Finance, (2005), The Boston Institute of Finance Stockbroker Course: Series 7, John Wiley & Sons, New Jersey.
• Curley M. T., (2008), Margin Trading from A to Z: A Complete Guide to Borrowing, Investing and Regulation, John Wiley & Sons, New Jersey.
• Rice S. M., (2014), 1,001 Series 7 Exam Practice Questions For Dummies, John Wiley & Sons, New Jersey.
• Rini W., (2003), Mathematics of the Securities Industry, McGraw Hill Professional, New York.
• The Securities Institute of America, Inc., (2014), Wiley Series 4 Exam Review 2015 + Test Bank: The Registered Options Principal Qualification Examination, John Wiley & Sons, New Jersey.
• Weiss D. M., (2009), Financial Instruments: Equities, Debt, Derivatives, and Alternative Investments, Penguin Group, New York.

Author: Weronika Kaca

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