CFA Level 1: Understanding Margin Requirements

Carmina Aburana is a sales assistant to Drew Door, a sales manager at Hicost Brokerage. Hicost has a policy of requiring at least 20% margin on stocks that are deemed illiquid or extremely risky. For these purposes, it creates and updates a list of such stocks on a weekly basis. Yoddly Yoo, Inc. is an up and coming internet firm whose stock has been on this list for some time now. One of Carmina's "blue chip" clients, Amadeus, has been speculating on Yoddly's stock for the past two weeks, repeatedly going in and out of the market. In this process, he has unfortunately generated significant losses and his margin on the account has fallen to 12%. To make up for the shortfall, Amadeus calls up Carmina and requests a "borrowing on the account" of 10% for the next 2 weeks, promising to pay a hefty interest rate of 38%on an annualized basis. Since Amadeus has never been in default, Carmina agrees to the arrangement and moves some funds from another client's account. There is no explicit rule at Hicost that prohibits such an arrangement, though it is clearly an oversight on part of the Compliance department. Drew notices this transaction and calls Carmina for an explanation. On hearing the explanation, he tells Carmina that such arrangements are in violation of the company rules and should not be repeated. After 2 weeks, Amadeus supplies the necessary margin for his account.