Trading on margin involves borrowing cash from your broker to make additional trades. The special memorandum account gets filled if those margin-bought investments start to go up in value. That extra, unrealized value gets accounted for in the SMA as a line of credit.
Probably best to explain this one with an example:
You deposit $10,000 into a trading account. Then you borrow an additional $10,000 on margin. You use the $20,000 to buy 1,000 shares of Flappy Jacks Inc., a maker of premium pancake oil extract. The shares are trading at $20 when you buy them. Within a few weeks, they're up to $25. The value of your stake is up to $25,000...a total unrealized gain of $5,000 (unrealized because it only becomes a real gain if you sell the shares and lock in the profit). Of the $5,000 in paper profits, $2,500 stays in the main account. This amount represents the gain posted using the your original $10,000 cash deposit. The other $2,500, the amount of gain related to your $10,000 margin loan, exists in the SMA.
The SMA largely exists as an accounting tool. The money is treated differently because it was earned on the margin loan, not on the cash you deposited. Once you sell the stock, and square up the margin loan, you can pay back the $10,000 (plus any interest) and transfer that $2,500 SMA amount into actual cash.
Related or Semi-related Video
Finance: What is a Wrap Account?31 Views
Finance allah shmoop what is a rap account Okay yeah
yeah inserted joke about eminem here a rap account with
a w wraps into one annual fee All of the
services you'd normally pay for ala carte at a given
brokerage that is a broker might charge you a one
percent rap account fee to manage all the assets you
have with her in return for things like quote no
fee unquote access to their proprietary mutual funds you get
toe by the mutual funds no load and the quotes
air there because there is a fee annually to manage
the fund But at least this way there is no
fee to buy into the fund or no load their
god it see how that works The rap account can
also include unlimited trading at quote no fee unquote as
well like quotes or there again because there's usually a
spread on each trade like you buy a twenty eight
dollars and twenty seven cents and you sell a twenty
eight dollars in nineteen cents So there's a seat since
spread they're they're still making money on each trade There
just isn't an incremental fee tacked on top of all
That so your broker khun get that second home in
the hamptons and that one percent feet Well that's based
on the total amount invested with the broker got it
So if you have a million dollars invested with them
it's ten grand a year for that rap account fi
system we'll wrap accounts often come with minimum investment levels
well above those of a mutual fund like twenty five
fifty grand or more But in having a one feet
covers all approach a broker is not incentivized to churn
the account or do really anything to generate commissions for
themselves because there ain't any The only thing they're incentivized
to dio is gather more of your assets or make
your assets be worth more so they can keep going
on the whole one percent dance Yeah the notion goes
in theory anyway that if the broker helps client invest
well over time the client will remain a loyal one
and stay with that broker for a very long high
margin to the brokers Time for many large brokerages rap
accounts allowed their clients to be able to buy various
flavors of funds mutual hedge or index at quote wholesale
Prices unquote That is if the fund is a captive
fund maintained by the brokerage The rap account allows the
client to buy with no commissioner upfront charges which is
kind of a nice nice deal for him Yeah quick
example If jay z gives his broker one hundred million
dollars under a rap account that charges one percent the
broker will charge a million bucks a year in return
for handling all of jay z's trading wiring and a
whole bunch of other services got it One percent on
the hundred million broker makes million bucks a year and
if jay z also has a rap account you know
with no w there Well there's always a chance Queen 00:02:45.555 --> [endTime] bee well pop in for a cameo
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