Haircut (finance)
In finance, a haircut is a percentage that is subtracted from the market value of an asset that is being used as collateral.[1] The size of the haircut reflects the perceived risk associated with holding the asset. However, the lender has a lien for the entirety of the asset.
For example, United States Treasury bills, which are seen as fairly safe, might have a haircut of 1%, while for stock options, which are seen as highly risky, the haircut might be as high as 30%. In other words, a $1000 treasury bill will be accepted as collateral for a $990 loan, while a $1000 stock option might only allow a $700 loan.
Lower haircuts allow for more leverage. Haircut has an important role on many kinds of trades, for example for Repo or Reverse Repo.
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[edit] ECB use of haircuts
The European Central Bank applies a haircut to all securities offered as collateral. The size of the haircut depends on the riskiness and liquidity of the security offered as collateral.[2]
[edit] LTCM and haircut fees
The hedge fund named LTCM was able to obtain practically next-to-zero haircuts as its trades were considered safe by its lenders. This was likely due to LTCM's clout and the fact that no counterparty had a total picture of the extent of its operations.[3]
[edit] As used for exchange-traded products
When used in the context of exchange traded products such as stocks, options, or futures, haircut is used interchangeably with the term margin. It is the amount of capital required by a broker to maintain the positions currently in a trading account. If haircut exceeds the account's capital, the broker can either require additional capital (e.g. margin call), or liquidate positions until the haircut no longer exceeds available capital.
[edit] Other uses
Haircut can also refer to the likely size of a loss.
[edit] References
- ^ What Does Haircut Mean?
- ^ ECB Risk control framework
- ^ Jorion, P. (1999), "Risk Management Lessons from Long-Term Capital Management"
