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Difficulty: Very hardFederal Reserve Board (FRB) and Margin Regulation

An investor opens a margin account with a registered broker-dealer and places an order to purchase $20,000 of common stock in an initial public offering (IPO) underwritten by the firm. The investor requests to borrow 50% of the purchase price from the broker-dealer using the newly purchased shares as collateral under Federal Reserve Board rules. Under FRB margin regulations (Regulation T, Regulation U, and Regulation X), how must this transaction be handled?

  1. The transaction must be paid for fully in cash because newly issued securities are non-marginable and cannot be used as collateral for credit until 30 days after the public offering date.Answer
  2. B
    The transaction may be executed on margin immediately provided the investor deposits the 50% Regulation T initial margin requirement of $10,000 within two business days of the trade.
  3. C
    The transaction is marginable immediately if the broker-dealer finances the customer loan by re-hypothecating the IPO securities to a commercial bank under Regulation U.
  4. D
    The Federal Reserve Board will freeze margin access on the purchase only if the transaction violates monetary policy targets set by the Federal Open Market Committee.

Answer

The transaction must be paid for fully in cash because newly issued securities are non-marginable and cannot be used as collateral for credit until 30 days after the public offering date.
Under Federal Reserve Board rules and federal securities laws, new issue distributions (such as IPOs) cannot be purchased on credit or used as collateral in a margin account until at least 30 calendar days have elapsed from the effective date of the offering. Therefore, the investor must deposit 100% of the purchase price ($20,000) in cash.

Step-by-Step Solution

1
Identify the type of security being purchased and the account type requested.
The investor is purchasing an Initial Public Offering (IPO) security in a margin account.
Margin eligibility rules enforced by the Federal Reserve Board differ between seasoned secondary market equity and new distributions.
2
Apply Federal Reserve Board margin rules regarding new issue distributions under Regulation T and Section 11(d)(1) of the Securities Exchange Act of 1934.
New issues sold via prospectus are strictly non-marginable for 30 days from the effective offering date.
Broker-dealers participating in a distribution are prohibited from extending credit on the newly issued securities during the underwriting and seasoning period.
3
Determine the required funding for the purchase.
The investor must deposit 100% of the $20,000 purchase price in cash.
Since the security cannot serve as margin collateral for 30 days, no credit extension (0% loan value) is permitted.

Key Concept

30-Day Margin Restriction on New Issues (IPOs)
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Topics

Federal Reserve Board (FRB) and Margin Regulation

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