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. Leveraged Loan

    Loans extended to companies or individuals that already have ...
  2. Collateral

    Property or other assets that a borrower offers a lender to secure ...
  3. Margin

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

    1. The difference between prices at which a market maker can ...
  5. Value Of Risk (VOR)

    The financial benefit that a risk-taking activity will bring ...
  6. Risk Financing

    The determination of how an organization will pay for loss events ...
RELATED FAQS
  1. What does it mean when the shares in my account have been liquidated?

    An account liquidation occurs when the holdings of an account are sold off by the firm in which the account was created. ... Read Full Answer >>
  2. My broker just sold securities out of my account without my permission. Is this legal?

    Your broker's actions are not legal unless he or she sold the securities under certain conditions. Let's look at the two ... Read Full Answer >>
  3. How does beta measure a stock's market risk?

    Beta is a statistical measure of the volatility of a stock versus the overall market. It's generally used as both a measure ... Read Full Answer >>
  4. What are some common questions an interview may ask during an interview for a position ...

    When interviewing for a job at an investment bank, a candidate is likely to answer questions about his career and education ... Read Full Answer >>
  5. How does the risk of investing in the electronics sector compare to the broader market?

    The risk of investing in the electronics sector closely approximates the risk of investing in the broader market. The electronics ... Read Full Answer >>
  6. How much of a diversified portfolio should be invested in the electronics sector?

    The electronics sector tracks closely with the broader market, making it a cyclical sector with average volatility. Electronics ... Read Full Answer >>
Related Articles
  1. Trading Systems & Software

    Backtesting: Interpreting The Past

    We offer some tips on this process that can help refine your current trading strategies.
  2. Options & Futures

    Margin Trading

    Find out what margin is, how margin calls work, the advantages of leverage and why using margin can be risky.
  3. Trading Strategies

    Understanding Bottoms & Bottoming Patterns

    Analysis lowers the risk of bottom picking by identifying common characteristics of securities transitioning from downtrends to uptrends.
  4. Economics

    What is Adverse Selection?

    Adverse selection occurs when one party in a transaction has more information than the other, especially in insurance and finance-related activities.
  5. Fundamental Analysis

    Explaining Expected Return

    The expected return is a tool used to determine whether or not an investment has a positive or negative average net outcome.
  6. Mutual Funds & ETFs

    U.S. Investors Are Seeking Opportunities Overseas

    A latest analysis leads to believe that many investors are applying a spring cleaning approach to their portfolios, rebalancing as the 1st quarter ended.
  7. Investing

    Three Portfolio Moves To Consider Now

    What portfolio moves should you consider making as the 2nd quarter kicks off? Before we focus on the future, let’s first reflect on the 1st Q surprises.
  8. Investing Basics

    Manage Investments And Modern Portfolio Theory

    Modern Portfolio Theory suggests a static allocation which could be detrimental in declining markets, making it necessary for continuous risk assessment. Downside risk protection may not be the ...
  9. Mutual Funds & ETFs

    6 ETFs to Fight Your Recession Jitters

    Are you worried about a recession? If so, consider these 6 ETFs.
  10. Active Trading Fundamentals

    Where And How Should You Make Your First Trade?

    New traders should enter markets that offer the greatest opportunity for learning their craft while keeping risk at a minimum.

You May Also Like

Hot Definitions
  1. Carrying Value

    An accounting measure of value, where the value of an asset or a company is based on the figures in the company's balance ...
  2. Capital Account

    A national account that shows the net change in asset ownership for a nation. The capital account is the net result of public ...
  3. Brand Equity

    The value premium that a company realizes from a product with a recognizable name as compared to its generic equivalent. ...
  4. Adverse Selection

    1. The tendency of those in dangerous jobs or high risk lifestyles to get life insurance. 2. A situation where sellers have ...
  5. Wash Trading

    The process of buying shares of a company through one broker while selling shares through a different broker. Wash trading ...
Trading Center