Risk-Based Haircut

AAA

DEFINITION of 'Risk-Based Haircut'

A reduction in the recognized value of an asset in order to produce an estimate for the level of margin or financial leverage that is acceptable to use when purchasing or continuing to own the asset. An analyst undertaking a risk-based haircut of an asset attempts to determine the chances of the asset's value falling below its current level, so that a sufficient buffer can be established to protect against a margin call.

INVESTOPEDIA EXPLAINS 'Risk-Based Haircut'

A risk-based haircut is important to do in order to provide a margin of safety to protect against the possibility of a margin call or similar type of over-leveraged position in a security. By artificially reducing the recognized value of an asset before undertaking a leveraged position in it, the actual market value of the asset must fall by an increased amount than if no haircut was applied in order for a margin call to take place. This decreases the chances of an ill-time margin call or forced sale of the security for a low price taking place in the investors account.

RELATED TERMS
  1. Collateral

    Property or other assets that a borrower offers a lender to secure ...
  2. Haircut

    1. The difference between prices at which a market maker can ...
  3. Margin

    1. Borrowed money that is used to purchase securities. This practice ...
  4. Leveraged Loan

    Loans extended to companies or individuals that already have ...
  5. Return On Equity - ROE

    The amount of net income returned as a percentage of shareholders ...
  6. Compound Annual Growth Rate - CAGR

    The year-over-year growth rate of an investment over a specified ...
Related Articles
  1. Backtesting: Interpreting The Past
    Trading Systems & Software

    Backtesting: Interpreting The Past

  2. My broker just sold securities out of ...
    Investing

    My broker just sold securities out of ...

  3. What does it mean when the shares in ...
    Investing

    What does it mean when the shares in ...

  4. Margin Trading
    Options & Futures

    Margin Trading

comments powered by Disqus
Hot Definitions
  1. Last In, First Out - LIFO

    An asset-management and valuation method that assumes that assets produced or acquired last are the ones that are used, sold ...
  2. Ghosting

    An illegal practice whereby two or more market makers collectively attempt to influence and change the price of a stock. ...
  3. Elasticity

    A measure of a variable's sensitivity to a change in another variable. In economics, elasticity refers the degree to which ...
  4. Tangible Common Equity - TCE

    A measure of a company's capital, which is used to evaluate a financial institution's ability to deal with potential losses. ...
  5. Yield To Maturity (YTM)

    The rate of return anticipated on a bond if held until the maturity date. YTM is considered a long-term bond yield expressed ...
  6. Net Present Value Of Growth Opportunities - NPVGO

    A calculation of the net present value of all future cash flows involved with an additional acquisition, or potential acquisition. ...
Trading Center