Special Memorandum Account: Meaning, Purpose and How it Works
There are several accounts in operation when it comes to stock markets. Each of these accounts serves a particular purpose and adheres to certain rules and regulations. A special memorandum account (SMA) is also one of them.
An SMA is basically a line of credit where brokerages deposit excess equity of margin accounts. Let’s delve a bit deeper into this concept to get an idea about its functioning.
What Is a Special Memorandum Account?
This is an investment account in which the extra margins present in the individual’s margin account get deposited. One of the major advantages of this account is that it increases the purchasing power of concerned investors.
Brokerage houses need to compute excess margins accumulated in a client’s margin account after each trading day. This is a routine that brokerages follow diligently, and an SMA allows them to transfer extra margins.
Now that you are well aware of the definition and meaning of a special memorandum account, let’s shift our focus to its other aspects.
How Does a Special Memorandum Account Work?
For functionality, there are two operational signals for this account – positive and negative special memorandum accounts. The negative SMA is detrimental to investors. You must take the necessary steps before the account’s value turns negative.
In an SMA, every deposit you make leads to a commensurate rise in the value of shares or derivatives they own. Moreover, if you are investing a part of your earnings like dividends, the special memorandum account would be in line with credits.
You are eligible to withdraw credits from your respective SMA. You can use this cash to purchase some additional stocks. It is important that you maintain a positive value for a special memorandum account if you wish to purchase new stocks.
What Is the Purpose of SMA?
One of the major objectives behind introducing this concept is to increase the purchasing power of an individual’s margin or brokerage account. This account locks in the profits earned in the margin accounts.
Things to Consider Before Opening a Special Memorandum Account
Here are some things that you should keep in mind before opening a special memorandum account:
- Brokerages have the responsibility to maintain an SMA along with a margin account.
- Excess or extra equity held by an SMA occurs when an account has more equity than required, i.e. more than 50%.
- The value of SMAs increase as the stock prices increase. However, a decrease in stock prices does not lead to a corresponding decrease in the value of SMA.
- When computing equity in a margin account, brokerages treat a single entry amount as a debit transaction in the margin account.
- It can also occur that a margin and a special memorandum account are debited and credited for the same amount. An increase or decrease in the value of an entry affects both these accounts.
A special memorandum account is a unique account that helps to increase the purchasing power of a trader. The main purpose of this account is to reflect the excess margin created during a transaction. Although SMAs offer more control over your investments, make sure to assess the benefits as well as risks of such accounts before opening one.
Frequently Asked Questions
Does SMA value get influenced by market value?
Yes, it gets affected by an increase and decrease in the market value of an asset. The value of this account increases with a rise in stock prices. But a fall or decline in asset prices will not lead to a commensurate fall.
How does the balance in an SMA get affected?
It is important to note that the balance in special memorandum accounts get affected by cash withdrawals from any brokerage account and the purchase of securities.
What are the major transaction entries in SMA?
The important transaction entries in a special memorandum account are payments of interests and dividends and depositing cash to maintain margin call requirements.
Can I withdraw cash from a Special Memorandum Account?
Yes, you can withdraw cash from these accounts as per prevailing rules and regulations. The primary purpose behind such a withdrawal should be purchase of additional securities.