Do First National Bank's Margin Requirements Apply to Substitutions and Withdrawals?
Question
First National Bank has made a loan to Mr. Good, secured by margin stock, to purchase margin stock. He trades stocks frequently, makes substitutions on loan collateral regularly, and sometimes withdraws collateral and does not replace it. Must FNB ensure that margin requirements are met after every substitution and withdrawal?
Answers
Explanations
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A. B. C. D.A
Under Regulation U of the Federal Reserve Board, a bank is required to maintain a certain amount of margin on loans secured by margin stock. This regulation is designed to protect both the lender and borrower against the risks of trading on margin.
In the scenario presented, First National Bank has made a loan to Mr. Good, secured by margin stock, to purchase margin stock. As Mr. Good trades stocks frequently, makes substitutions on loan collateral regularly, and sometimes withdraws collateral and does not replace it, the question is whether FNB must ensure that margin requirements are met after every substitution and withdrawal.
Answer choice A, "Yes. The margin requirements must be met at all times," is correct. According to Regulation U, a lender must maintain a margin equal to at least 50% of the current market value of the margin stock. In this case, if Mr. Good makes a substitution or withdrawal, the market value of the collateral securing the loan changes, which may affect the margin requirements. Therefore, FNB must ensure that the margin requirements are met after every substitution and withdrawal to comply with Regulation U.
Answer choice B, "No. If the margin requirements were met when the loan was made, there are no further requirements," is incorrect. Even if the margin requirements were met at the time of loan origination, they may change due to changes in market value or collateral.
Answer choice C, "No. The bank is only required to ensure that withdrawals do not violate margin requirements; collateral substitutions are not covered," is also incorrect. Collateral substitutions may affect the margin requirements, so FNB must ensure that the margin requirements are met after every substitution and withdrawal.
Answer choice D, "No. In this case, the margin requirement must be met only when the loan is renewed," is incorrect. The margin requirement must be met after every substitution and withdrawal to comply with Regulation U.
