Financial Tips: Know What ‘Haircut’ Means in Stock Market, Aspects, Examples, and More

Use of Haircut In Stock Market

The haircut is calculated as a percentage of the difference between the two values. Securities are generally devalued when used as collateral because lending parties require a cushion in case the market value falls. When collateral is pledged, the amount of the haircut is determined by the lender's associated risk. These risks include any variables that may affect the value of the collateral if the lender is forced to sell the security due to the borrower’s loan default. Price, volatility, the credit quality of the asset’s issuer, and the collateral’s liquidity risks are all factors that can influence the amount of a haircut.

Examples of Haircuts

Margin Trading

When an investor borrows money to buy stocks, the brokerage firm may apply a haircut to the stock’s value to ensure adequate collateral.

Repurchase Agreements (repos)

The borrower provides collateral (usually bonds) to the lender in these short-term financing arrangements. To protect against price fluctuations, the lender reduces the value of the bonds.

Margin Loans

When individuals borrow money to invest in securities, the lender may impose a minimum margin requirement based on the haircut value of the collateral.