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

Audit systems, Enron did not manages its trade account receivable in signif...

Enron did not manages its trade account receivable in significant manner that made huge financial loss for the organizations. Hence, the management faced biggest fraud due to the f

Explain why accounting profits and cash flows are different, Explain why ac...

Explain why accounting profits and cash flows are not the same thing. Ans: Stock value relies on future cash flows, their timing, and their riskiness.  Profit calculations do n

Working Capital Management, The management of Nelson plc wish to estimate t...

The management of Nelson plc wish to estimate their firm’s equity beta. Nelson has had a stock market quotation for only two months and the financial management feels that it would

What is financing decision, What is Financing Decision Provision of ...

What is Financing Decision Provision of funds required at proper time is one of theprimary tasks of finance manager. Identification of the sources, deciding whichtypes of fu

Why is capital budgeting analysis so important to the firm, Why is capital ...

Why is capital budgeting analysis so important to the firm? The major goal of the financial manager is to maximize shareholder wealth. Capital investments along with positive N

Indirect-cost pools, 1. Increasing the number of indirect-cost pools is gua...

1. Increasing the number of indirect-cost pools is guaranteed to sizably increase the accuracy of product or service costs.do you agree? Support your anser using examples 2. The

CASELET, Prepare your recommendation on Agarwal Cast Company

Prepare your recommendation on Agarwal Cast Company

Operating cycle, discuss the applicability of operating cycle in poultry in...

discuss the applicability of operating cycle in poultry industry[consider broilers]

Skills, what are some of the skills in asmall scale business

what are some of the skills in asmall scale business

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