Margin requirement on a repo

CFA Level III Fixed Income
#1

In EOC 15 of the reading on “fixed income portfolio Management - Part III”, they mention that the margin requirement will be higher when the collateral is illiquid.

I totally understand that the conditions for the investor trying to borrow money through a repo are less advantageous when the collateral is illiquid.

What I am not sure about is what is a margin requirement? In the curriculum they mention the various factors that influence the repo rate but I don’t remember reading about margin requirement. I know what a margin call is in the case of a swap but…

#2

the percentage of collateral you post.

#3

Sorry, can you please explain further? I am not sure what it means.

#4

Suppose that you borrow USD10 million in an overnight repo.

If you post very liquid collateral, you may have to post only USD 5 million in value.

If you post very illiquid collateral. you may have to post USD 8 million in value.

#5

Is it possible that a “haircut” is required? Thank you

#6

Its the difference btwn what you borrowed and what in return you got

#7

Ok so it’s similar to a Loan to Value ratio consideration. The worse your collateral (for ex: illiquid) the lower the ratio would be. Although legally, repo is considered as a sale and repurchase and not as a loan, therefore we don’t use the concept of LTV.

Is that it more or less?

thanks!

#8

So essentially the Margin Requirement on a Repo is the Haircut %. For example, if i Repo a security out to you at 102% then i am giving you a security worth 102$ and you are giving me cash of 100$. The margin requirement is the 2$, if the security drops in value then the person repoing out the security could be margin called and have to send either more securities or cash. So an illiquid security should have a larger haircut or higher margin requirement. In my 2% example it may be 10% instead.

#9

Although legally a repo is a sale and repurchase, in practice it’s more like a collateralised loan. The higher the quality of your collateral, the less of it you have to post to enter the repo. Liquidity is considered a positive quality, therefore the more liquid your collateral, generally All else equal, you have to post less of it to get the same repo deal.

The “margin requirement” is just another term for the amount of collateral you ned to post.

#10

Thanks guys. This all makes total sense to me. I was just confused because the course talks mainly about what influences the rate and not the margin (i don’t have the course with me now but from the top of my head…). So i guess it’s the same characteristics of the collateral that would influence the margin as the ones influencing the rate.

#11

This is unclear to me why is the collateral less than what you ate borrowing?

#12

Perhaps they trust you.

Foolish, I know, but there you go.

#13

dont think thats how the market works. liquid collateral may result in a lower repo rate, but collateral > borrowed amount

#14

Fair enough. Change the amount borrowed to USD 4 million.

The point remains the same: you have to post more collateral if it’s illiquid than if it’s liquid.