A:

A haircut rate is a measure that reduces the value of any collateral used in a loan to ensure that when the effects of volatility and adverse price changes are taken into consideration, the collateral will still have enough value so that the lender does not realize any loss.

Haircut rates are imposed by clearing corporations to ensure adequate capital requirements, margin and collateral levels. Broker-dealers are required by law to meet capital requirements. The net capital requirements required by various institutions are stated under SEC Rule 15c3-1.

Haircut rates will vary depending on the instrument and the length, type or riskiness of the transaction. Under the SEC rule, the haircut rate for an exchange-traded fund (ETF) such as a Spider is 10%, compared to a 2% haircut for a money market fund. Notice how a higher rate is imposed on assets that are riskier.

As another example, a 30% haircut rate may be imposed when an investor wishes to use shares which she already holds in her account as collateral for margin required for a separate transaction. The market value of the shares is devalued by 30% to give the lending institution a cushion in case the value of the collateral experiences a sharp decline.

For information on the effects of these margin requirements on the average investor, check out our Margin Trading Tutorial.

RELATED FAQS
  1. What is the difference between asset-based lending and asset financing?

    In the most common usage, the terms "asset-based lending" and "asset financing" refer to the same thing. Asset-based lending ... Read Answer >>
  2. When did people first start using collateral to secure loans?

    Read about the history of lending and collateral, including a time when an entire nation was pledged as collateral for all ... Read Answer >>
  3. How exactly does buying on margin work and why is it controversial?

    Learn how purchasing stock on margin works, and understand the risk associated with margin accounts that make the strategy ... Read Answer >>
  4. Do you have to sell your stocks when you get a margin call?

    Understand the implications of a margin call and what an investor's options are when the stock he purchased on margin falls ... Read Answer >>
  5. How are margin calls regulated by the SEC?

    Learn how FINRA and the Federal Reserve Board regulate trading in margin accounts, and see how brokers can liquidate positions ... Read Answer >>
Related Articles
  1. Trading

    What Happens in a Haircut?

    One meaning of haircut is the difference between prices at which a market maker can buy and sell a security.
  2. Insights

    3 Of History's Costliest Hairdos

    A look at three costly hairdos and the impact that they had, both financially and socially.
  3. Personal Finance

    What Is Collateral?

    Collateral is property or other assets that a borrower offers a lender to secure a loan. If the borrower stops making the promised loan payments, the lender can seize the collateral to recoup ...
  4. Investing

    How Does Securities Lending Work?

    Securities lending is the act of loaning a stock or other security to an investor or firm.
  5. Small Business

    Using Collateral to Obtain a Loan for Your Small Business

    Learn what assets can be used as collateral for an asset-based loan, and find out best practices when seeking asset-based lending.
  6. Investing

    Who Has The Most Exposure To Greece?

    Standard & Poor's cut Greece's debt rating to one notch above default. Find out who has the most to lose.
  7. Investing

    A Primer On Collateralized Debt Obligation (CDOs)

    A collateralized debt obligation, or CDO, is a structured financial product backed by a pool of loans. When a retail or commercial bank approves loans such as mortgages, auto loans or credit ...
  8. Personal Finance

    What Is A Mortgage?

    A mortgage is a loan used to purchase a home, where the property serves as the borrower's collateral.
  9. Investing

    Cash Flow Lending Vs. Asset-Based Lending

    When companies need financing, they rely on two primary forms of lending: cash flow-based and asset-based lending. We look at the pros and cons of each.
  10. Financial Advisor

    Margin Investing Gets A Bad Rap, But For The Thrill-Seeker, It's Worth It

    Investing on margin can be profitable but it's a risky play that needs care.
RELATED TERMS
  1. Haircut

    1. The difference between prices at which a market maker can ...
  2. Risk-Based Haircut

    A reduction in the recognized value of an asset in order to produce ...
  3. Collateral Value

    The estimated fair market value of an asset that is being used ...
  4. Additional Collateral

    Additional assets put up as collateral by a borrower against ...
  5. Advance Rate

    The maximum percentage of the value of a collateral that a lender ...
  6. Collateral

    Property or other assets that a borrower offers a lender to secure ...
Hot Definitions
  1. Redlining

    The unethical practice whereby financial institutions make it extremely difficult or impossible for residents of poor inner-city ...
  2. Nonfarm Payroll

    A statistic researched, recorded and reported by the U.S. Bureau of Labor Statistics intended to represent the total number ...
  3. Conflict Theory

    A theory propounded by Karl Marx that claims society is in a state of perpetual conflict due to competition for limited resources. ...
  4. Inflation-Linked Savings Bonds (I Bonds)

    U.S. government-issued debt securities similar to regular savings bonds, except they offer an investor inflationary protection, ...
  5. Peak Globalization

    Peak globalization is a theoretical point at which the trend towards more integrated world economies reverses or halts.
  6. Phishing

    A method of identity theft carried out through the creation of a website that seems to represent a legitimate company. The ...
Trading Center