Most of the times, Whenever one decides to take a loan, he/she needs to deposit collateral with the bank for the loan to be sanctioned. Not every collateral bears the same amount of risk and so they cannot be valued equally.
Take for example, a 100 rs. treasury bond and a 100 rs. stock of company X. Treasury bond is less risky and so with a 100 rs treasury bond as a collateral, a loan of say 90 (say) can be obtained but whereas with a 100 rs stock as collateral, less than 90 rs loan , say 70 rs loan, can be obtained.
And so the Haircut is 10% for Treasury bond and 30% for a stock (in this example). In more generalized terms, Haircut refers to the percentage by which an assets market value is reduced for the purpose of calculating capital requirements, margins and collaterals.
The whole point of Haircut is to have a collateral which is atleast worth the value of loan at any point of time. And at any point of time, if the value of the collateral decreases to less than the value of the loan, then the lender of the money(say bank) will have the risk of loosing on the money i.e. if the borrower defaults then the bank can only recover money to the value of the collateral and since this value has been decreased to less than the value of loan, the bank looses on some part of the loan.
Take for example, a 100 rs. treasury bond and a 100 rs. stock of company X. Treasury bond is less risky and so with a 100 rs treasury bond as a collateral, a loan of say 90 (say) can be obtained but whereas with a 100 rs stock as collateral, less than 90 rs loan , say 70 rs loan, can be obtained.
And so the Haircut is 10% for Treasury bond and 30% for a stock (in this example). In more generalized terms, Haircut refers to the percentage by which an assets market value is reduced for the purpose of calculating capital requirements, margins and collaterals.
The whole point of Haircut is to have a collateral which is atleast worth the value of loan at any point of time. And at any point of time, if the value of the collateral decreases to less than the value of the loan, then the lender of the money(say bank) will have the risk of loosing on the money i.e. if the borrower defaults then the bank can only recover money to the value of the collateral and since this value has been decreased to less than the value of loan, the bank looses on some part of the loan.
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