Rehypothecation: An Illustration
Suppose a customer purchases 1,000 shares at $60 and deposits 50% of the price in a margin account and borrows the balance from her broker. The customer’s account will have a debit balance of $30,000.
The broker-dealer is allowed to borrow up to $30,000 to finance its operations, the amount of the account’s debit balance. A bank will undoubtedly require that the borrowed amount be fully collateralized to protect the bank loan. The broker, however, is allowed to use up to 140% of the debit balance as collateral for the loan and no more. Any other collateral must come from other sources of capital.
Rehypothecating 140% of the customer’s debit balance amounts to a value equivalent to 700 shares of stock. These 700 shares are called margin securities.
