Margin Ratio
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The definition of “Margin Ratio” is the same between the 2011 GMRA, the 2000 GMRA and the 1995 GMRA. It is important to remember that the concept of the “Margin Ratio” is only relevant for “Method A” when calculating “Transaction Exposure”.
At a high level, the “Margin Ratio” is an expression of how much excess collateral a party to a Repurchase Transaction has in order to cushion itself against the risk of loss which might result from fluctuations in the value of that collateral.
The “Margin Ratio” is calculated with respect to each Repurchase Transaction and is equal to the “Market Value” of the Purchased Securities at the time when the transaction was entered into divided by the Purchase Price, in other words:
MR = MVt=0 / PP
This is a known number. When a Repurchase Transaction is executed, the market value of the underlying securities provided as collateral is known. The “Purchase Price” (in loan terms, the amount that the lender was prepared to ‘lend’ against that collateral, is also known (it is specified within the confirmation to the repo transaction)). The market value of the securities provided as collateral should really have a HIGHER value than the “Purchase Price” (in other words, the amount the lender is willing to lend) so this number should be GREATER than 1.
How does this work in practice?
Imagine that the market value of the securities underlying the Repurchase Transaction was GBP 100 at the time when the transaction was executed. However, we had agreed that the “Purchase Price” was GBP 97 (in other words, we were only prepared to ‘lend’ GBP 97 against collateral worth GBP 100). In these circumstances, the “Margin Ratio” would be:
100 / 97 = 1.031 or 103.1%
This creates a cushion of – roughly – 3%. In other words, the value of the securities underlying the Repurchase Transaction could fall by about 3% before the Buyer risks not having enough collateral to cover its potential losses (should the Seller default).
As mentioned previously, the concept of “Margin Ratio” is one of the key inputs into calculating “Transaction Exposure” under “Method A”. In this context, it acts to boost the value of “Repurchase Price” (in other words, the ‘loan plus interest’ that must be returned at maturity of the underlying Repurchase Transaction) – BEFORE that figure is compared to the market value of the securities which represent the ‘collateral for the loan’ In doing so, a ‘collateral cushion’ is hardwired into the “Transaction Exposure” calculation under “Method A”.
The “Margin Ratio” also plays an important role in the process of “Repriced Transactions”. By way of reminder, the parties can “Reprice” a transaction as an alternative to traditional margining. If they choose to do so, the cash leg of the transaction is effectively adjusted to ‘fit the amount of available collateral’. In essence, the “Purchase Price” (in other words, the amount of the loan) under the “Repriced Transaction” cannot exceed the “Market Value” of the securities (in other words, the amount of available ‘collateral’) divided by the Margin Ratio. In this way, a collateral cushion is also built into the repricing process. The “Margin Ratio” performs an almost identical role when transactions are “Adjusted” rather than “Repriced”. “Transaction Adjustment” is another alternative to traditional margining (except that, in these circumstances, the securities leg of the transaction is adjusted to fit the ‘then outstanding amount of the loan’). However, the point is that, again, the “Margin Ratio” acts to ensure that the ‘loan’ is over-collateralised in order to provide a cushion against swings in market value.
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