Margin and marking to market, Financial Management

Assignment Help:

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. 

Illustration 

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.


Related Discussions:- Margin and marking to market

Give subject matter of participation, Q. Give subject matter of participati...

Q. Give subject matter of participation? Subject matter of participation by and large the workers interests in participation varies with the nature of issues' involved in parti

Explain pro forma financial statements and a cash budget, What is the diffe...

What is the difference between pro forma financial statements and a cash budget?  Explain why pro forma financial statements are not used to forecast cash needs. Pro forma

Prepare a report for the managing director, The Managing Director of your f...

The Managing Director of your firm is thinking aloud about an appropriate gearing level for the company: "The consultants I spoke to yesterday explained that some theorists adva

Define main trends which prevailed in international business, Discuss the t...

Discuss the three main trends which have prevailed in international business throughout the last two decades. The 1980s brought a fast integration of financial markets and inter

Corporate governance, CORPORATE GOVERNANCE Corporate governance can be ...

CORPORATE GOVERNANCE Corporate governance can be stated in different ways, for example: The Private Sector Corporate Governance Trust (PSCGT) defines that corporate governan

Sensex, What is Financial index & commodity index? Method of index uses in ...

What is Financial index & commodity index? Method of index uses in calculation? Weighted average method? How to calculate index?

Explain life insurance in detail, Question 1 Insurance is protection again...

Question 1 Insurance is protection against possible financial loss. Explain life insurance in detail Question 2 Mutual funds are a composite of stocks, bonds, and securities,

Unity of command, Unity of Command Unity of command is the principle in...

Unity of Command Unity of command is the principle in which each subordinate should be responsible to only one manager.

Why total assets equal the sum of total liabilities & equity, Why do total ...

Why do total assets equal the sum of total liabilities and equity?Explain. Assets = Liabilities + Equity Assets are the entities of value a business owns. Liabilities ar

Finance, #qSeven years ago, after 15 years in public accounting, Stanley Bo...

#qSeven years ago, after 15 years in public accounting, Stanley Booker, CPA, resigned his posiition as Manager of Cost Systems for Davis, Cohen, and O''''''''Brien Public Accountan

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd