What Is A Special Memorandum Account (SMA) & How Does It Work?

What Is A Special Memorandum Account and How Does It Work




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The Special Memorandum Account is one that confuses specialists, traders and investors, and the term Special Managed Account (SMA) is sometimes used interchangeably with the Special Memorandum Account. However, the broker's Special Memorandum Account is a distinct account that acts similarly to a credit account.

There are two operational signals for the SMA: a negative SMA and a positive SMA. A negative SMA is never helpful for an account. To prevent a negative SMA account an investor must be aware of SMA to prevent a negative SMA account. Aside from that, investors must grasp what occurs in the event of a negative SMA. The Special Memorandum Account operates as follows:

  • When investors make a cash deposit, the value of the stocks or options they own rises.
  • When they deposit a portion of the earnings, including dividends, into their Special Memorandum Account.

The SMA is analogous to credits. An investor may withdraw these credits from the SMA as cash to access additional stocks (purchase more of them), increasing their buying power.

Keep an Eye On SMA

The SMA, as well as its value, has to be tracked since traders will get a margin call from their broker if the account's value falls below zero. A margin call is a term used to describe the situation in which a broker requests more cash or assets from a client to compensate for losses and fulfil margin commitments.

To fulfil the margin requirements, the traders will be obliged to sell part of their stocks, which is never a good thing in the financial industry. Traders must also have a positive Special Memorandum Account in order to purchase anything new.

The Function of a Special Memorandum Account

Many traders also commonly misinterpret the reasons for creating Special Memorandum Accounts. The Special Memorandum Account primarily provides additional purchasing power to the client's margin account (brokerage account).

Is SMA Affected By Market Value?

The Special Memorandum Account may only be affected by an increase in the current market value. Another interesting point about the SMA account balance is that it grows as the value of the securities rises but does not depreciate if the value of the securities declines.

This occurs because the purpose of this account is to preserve the purchasing power produced by unrealized profits for future purchases. Investors would have to withdraw the excess equity from the bank and deposit it for future purchases if the Special Memorandum Account did not exist.

Wrapping Up

The Special Memorandum Account primarily reflects the excess margin created, and the SMA account multiplied by two indicates the margin account's purchasing power. The SMA's objective is also to offer the broker more purchasing power over the customers' margin accounts. Investors must also realise that the Special Memorandum Account occurs when the account's equity margin exceeds the 50% level specified by federal Reg T rules. Having a Demat and trading account is essential if you are trading derivatives or investing in upcoming IPOs. If you don't already have one, go to Motilal Oswal right now and open a free demat account.

 

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