Haircut on Repurchase Agreement

While a 50% discount is the norm for margin accounts, a risk-based discount can be increased if the deposited securities carry liquidity or volatility risks. For example, a portfolio of highly volatile leveraged exchange-traded funds (ETFs) can be as much as 90%. Penny stocks, which present potential price, volatility and liquidity risks, generally cannot be used as collateral for margin accounts. In finance, a discount refers to the reduction applied to the value of an asset for the purpose of calculating capital requirementsIn net working capitalNet working capital (NWC) is the difference between current assets (minus cash) and current liabilities (minus liabilities) on its balance sheet. It is a measure of a company`s liquidity and ability to meet the company`s short-term obligations as well as fund operations. The ideal position is for margin and safetySustainable assetsActive assets are assets with a physical form that have value. Examples include tangible capital assets. Tangible property is seen and felt and can be destroyed by fire, natural disaster or accident. Intangible assets, on the other hand, have no physical form and consist of things like the level of intellectual property. In other words, it is the difference between the amount of a loan granted and the market capitalization of the market value that is the most recent market value of a company`s outstanding shares.

The market capitalization corresponds to the current share price multiplied by the number of shares outstanding. The investment community often uses the value of market capitalization to evaluate the companies of the asset to be used as collateral for the loan. The impairment is expressed as a percentage. The amount of the discount also depends on the liquidity of the guarantee. If the asset is highly liquid, it is easy to sell it quickly and without loss of value. Therefore, a smaller reduction is imposed. An asset that is much more difficult to sell at its fair market value will have a larger discount. Government bonds are safe and liquid instruments.

Therefore, they have a much smaller discount compared to other financial instruments. The financial term “haircut” began and continues to be used as a reference to valuation haircuts applied under the U.S. Securities and Exchange Commission`s net capital rule. The net capital rule was adopted to protect public investors by establishing standards of financial accountability for broker-dealers and requires that a dealer has sufficient liquidity at all times to cover its current debt. The SEC explained the role of haircuts in the calculation of net capital in 1967: on the other hand, securities whose prices are highly volatile when used as collateral tend to have high discounts. A haircut is sometimes called the spread of the market maker. Because market makers can trade with very thin spreads and low transaction costs, they can constantly make small splinters or profit (or loss) discounts throughout the day. A discount can also be considered as a complement to the loan-to-value ratio (taken together, they make 100%). For example, when central banks lend money to commercial banks, the Central BankDental Reserve (the Fed)The Federal Reserve is the central bank of the United States and is the financial authority behind the world`s largest free market economy. asks for guarantees. However, a discount is applied – a reduction in the value of the guarantee. Suppose an asset of $1 million at market price would only be enough to guarantee a $700,000 loan at a 30% discount.

By devaluing the assets provided as collateral, the lender gains a cushion, a level of risk coverage to avoid declines in market value. The term is used less often as the spread of the market maker. The term haircut is used because the spreads of the market maker are so thin. When the guarantee is pledged, the degree of discount is determined by the amount of associated risk for the lender. These risks include all variables that may affect the value of the collateral in the event that the lender has to sell the collateral due to a borrower`s default. Variables that can affect this amount of a haircut include the price, volatility, credit quality of the issuer of the asset (if any) and the liquidity risks of the collateral. .