Margin and marking to market, Financial Management

The collaterals used in the repo market are high quality securities; but they are also not free from credit risk. In our earlier example, we see the dealer borrowing Rs.1 crore using the purchased securities as collateral. If, for any reason, the dealer is unable to buyback the securities, the customer is left with securities. If the interest rates increase the market value of the government securities would decrease, leaving the customer with securities worth less than the loaned amount. If the interest rates decline, the value of the collateral would be greater than the loaned amount and the dealer is concerned about the return of the securities. Therefore repos should be carefully structured to reduce credit risk exposure. The amount lent to the borrower should always be less than the current market value of the security. The amount by which the market value of the securities exceeds the loan amount is termed as repo margin or margin. This margin gives a little cushion to the lender in case the interest rates increase as it would lead to decline in the market value of the securities. Generally, an amount between 1% to 3% of the market value of the securities is maintained as margin. For less liquid or price sensitive securities the margin could be as high as 10% or more. 


Amount needed by the dealer = Rs.10,00,000

Repo rate = 0.06

Repo term = 1 day

Margin = 2%.

Therefore, the margin in absolute terms would be 2% of 10, 00,000, i.e. Rs. 20,000

Amount borrowed = Rs.9, 80,000

The interest charged would be on the amount borrowed i.e. 9, 80,000 and not on 10,00,000.

The interest payable would be:

   Interest = 9, 80,000 x 0.06 x 1/ 360 = Rs.163.33.

Credit risk involved in these transactions can also be reduced by marking collaterals to market on a regular basis. This process is known as mark-to-market. The value of a position at its market value is recorded daily and compared to its initial price. When the market value declines this would result in a deficit. The customer would ask the borrower to take care of the margin deficit by providing additional cash or securities which can be used as collateral. Similarly, if the market value of the securities increases, the customer may transfer the excess margin to the borrower in form of cash or securities.

Posted Date: 9/11/2012 1:41:39 AM | Location : United States

Related Discussions:- Margin and marking to market, Assignment Help, Ask Question on Margin and marking to market, Get Answer, Expert's Help, Margin and marking to market Discussions

Write discussion on Margin and marking to market
Your posts are moderated
Related Questions
How do I calculate the average return for T over a five year period?

Q. Describe the basic Career stages? The proper way to analyze and discuss career is to look at them as made up of stages. We can identify five career stages that people most p

The difference between the cost of attending a particular school and the expected family contribution, minus any other financial aid.

What are the social and contemporary issues in financial management?

1.  Suppose Bank one offers a risk free interest rate of 5.5% on both savings and loans, and Bank Enn offers a risk free interest rate of 6% on both savings and loans. What arbitra

#questAs an assistant vice president at a regional bank, your boss has tasked you to acquire $100 million of residential mortgages to be securitized in a pass-through MBS. There mu

Question 1: i) What is meant by Cost and Benefit Analysis? Illustrate your answer with the use of empirical and hypothetical examples. ii) What are the benefits of conductin

Valuation and Exit Valuation: The Net Asset Value is used as a base for ascertaining the prices applicable to investor subscriptions and redemptions. Fund administrator perform

Compare diversifiable and nondiversifiable risk. Which do you believe is more significant to financial managers in business firms? Actually Diversifiable risk can be dealt with b