Definition and example of free credit balance

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What is the free credit balance?

Free credit balance refers to cash held in a client’s margin account with a broker who can withdraw on demand at any time. The free cash balance is calculated as the total money remaining uninvested in a margin account after taking into account margin requirements, proceeds from short sales, dividends received, and pending purchase transactions. regulation. Interest is sometimes paid by brokers on the free credit balance.

Key points to remember

  • The free credit balance takes into account all transactions and margin requirements and is the amount of capital available for withdrawal.
  • Some brokers, but not all, pay interest on free credit balances.
  • Free credit balances in the United States are regulated by the SEC and FINRA.

Understanding the free credit balance

In a cash account, the credit balance is the amount of money left over after all purchases, and it’s free of withdrawal restrictions. However, in a margin account, the account’s credit balance includes not only the cash remaining in the account, but also the proceeds from short sales as well as the money used to meet the margin requirements, excess margin and power. purchase. Because the credit balance of a margin account includes both unrestricted and restricted amounts, the free credit balance is created to determine the total amount that can be withdrawn by the account holder.

Although not required by law, some brokers pay interest on funds clients hold in free credit accounts. Some brokers offer account holders the option of periodically transferring funds held in their free credit balance accounts to short-term, highly liquid accounts such as FDIC insured bank accounts or money market funds. Brokers who offer this option must have a policy in place and follow it to receive authorization from clients, whether oral or written, to make transfers or otherwise invest funds held in these accounts.

Regulation respecting free credit balances

Since the amounts held in credit balance accounts are client funds, held by brokers, they are highly regulated. The regulations are designed to prevent the misuse of client funds by brokers as well as the loss of funds in the event a broker becomes insolvent or faces liquidity issues.

The Securities and Exchange Commission (SEC) requires brokers to perform a weekly calculation to determine the amounts of funds payable or receivable from a client’s free credit account. The Financial Sector Regulatory Authority (FINRA), the brokerage industry’s self-regulatory body, requires brokers to notify clients of their account balances by providing written statements quarterly, unless customers do not choose not to receive such statements. FINRA also requires brokers to provide it with details of the total amounts they hold at the end of the month in free credit balances in margin and cash accounts on a monthly basis.

Examples of Free Credit Balances in Trading Accounts

Suppose an investor deposits $ 10,000 into a margin trading account. After funds are deposited, if no transaction has been completed, the free credit balance is $ 10,000. This is the amount of capital that can be used for trading or withdrawn.

Suppose the trader buys 100 shares for $ 50. It costs $ 5,000. Their free credit balance is now $ 5,000 (excluding commissions).

Cash dividends received for the positions will be added to the free credit balance. Suppose the investor receives $ 50 in dividends on his position. Their free credit balance is now $ 5,050.

Interest may also be paid to the investor by the broker on the free credit balance. If this is the case, interest will be charged on the free credit balance which will be added to its total.

If the stock was bought with a 50% margin, the trader is required to maintain at least $ 2,500 on the $ 5,000 position to fund the trade. In this case, the free credit balance is $ 7,500 ($ 10,000 – $ 2,500), excluding commissions.

The trader is required to pay interest on margin positions. Interest will be deducted from the free credit balance, reducing it over time. At the same time, interest can be paid on the free credit balance, if the broker offers it.

Similar to the example of the no-margin account, the dividends received will be added to the account balance and will increase the free credit balance.

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