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

WACC, Saven Travel Corporation is considering several investment opportunit...

Saven Travel Corporation is considering several investment opportunities in order to diversify its operations. Mr. Saven, president, is trying to determine the firm''''s cost of ca

Definition, what is financial management?

what is financial management?

Loan schedules - fixed vs floating, Consider a mortgage example to nance ...

Consider a mortgage example to nance the purchase of a house or flat. You may use a real example or create a ctitious one. Search for di erent types of mortgages currently on o e

Total return analysis, A trade is assessed on the basis of its perfor...

A trade is assessed on the basis of its performance. Performance can be defined as the expected total return over and above the investment horizon of the trade. T

What is gatt, What is GATT, and what is its goal? GATT is the General A...

What is GATT, and what is its goal? GATT is the General Agreement on Tariffs and Trade it is a agreement that seeks to decrease trade barriers among participant nations.

State about the country analysis and political risk, Country analysis and p...

Country analysis and political risk Country analysis could use tools for example PEST factors in order to strategically analyse countries. Political risk

Risk, You are still a consultant for the Excellent Consulting Group. You ha...

You are still a consultant for the Excellent Consulting Group. You have completed the first assignment, developing and testing a forecasting method based on linear regression (Case

What is working capital, What is working capital? Working capital compr...

What is working capital? Working capital comprise of the current assets of the firm.

Operating cycle, Uses of operating cycle in business

Uses of operating cycle in 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