The definition of “Market Value” is used for the purposes of calculating the value of securities under the GMRA.  As such, it plays a key role in the margin maintenance, transaction repricing, transaction adjustment and substitution provisions.  As a concept, it also lies at the heart of key definitions such as the “Margin Ratio”, “Net Margin” and “Transaction Exposure”.

In general, the “Market Value” is the “dirty price” of the security in question.  The “dirty price” of a security is the rice that INCLUDES accrued interest/dividend.  So, for example, if we had a bond worth GBP 100 and we know that it pays 5% interest per annum, all other things being equal, its “dirty price” would be GBP 101.25 after 3 months, GBP 102.50 after 6 months, GBP 103.75 after 9 months and GBP 105 after 12 months (the point at which the dividend is paid).  At the moment the dividend is paid, the value of the security will slip back to GBP 100 (because you have to wait another year for the next batch of interest to accrue in full).

When the price of a security is quoted WITHOUT including accrued interest/dividend, this is known as the “clean price”.

The “Market Value” is obtained from a generally recognised pricing source agreed to by the parties (the pricing source is specified within Annex I of the GMRA).  In this sense, it should be distinguished from the concept of “Default Market Value” – which relies on a different methodology and is only used in a close-out scenario.  There is no mention as to whether the “Market Value” is the bid price, the offer price or the mid-market price.

Under the 1995 and 2000 GMRA’s the “Market Value” of a suspended security was regarded as being zero.  This would have required the provider of those securities to ‘top up’ collateral.  This position changed under the 2011 GMRA – now the “Market Value” of suspended securities is simply whatever their market value is in reality.  Of course, this value may have fallen drastically if the security itself has been suspended, which still may result in a requirement to ‘top-up’.

Method A

“Method A” is one of the approaches to calculating “Transaction Exposure” under a Global Master Repurchase Agreement.  It is sometimes referred to as the “initial margin” approach.   This is because, essentially, the Seller pays a premium (in terms of the collateral that it has to transfer) over the cash which is paid over by the Buyer.  The “initial margin” element of “Method A” is captured within the definition of the “Margin Ratio”.

Under “Method A”, “Transaction Exposure” (E) equals:

(R*MR) – MV

where:

“R” is the “Repurchase Price” (in other words, the amount of the ‘loan plus interest’ to be repaid);

“MR” is the applicable “Margin Ratio” (the “Margin Ratio” is equal to the “Market Value” of the Purchased Securities at the time when the Transaction was entered into divided by the Purchase Price (i.e., the amount of the ‘loan’).  In other words, it is a number that represents how much excess collateral exists.  The hope is that this number is greater than 1, otherwise there would be insufficient collateral to cover the ‘loan’; and

“MV” is the market value of Equivalent Securities at the time of calculation.

“Method A” is considered in more detail under the definition of “Transaction Exposure”.

Method B

“Method B” is another approach to calculating “Transaction Exposure” under a Global Master Repurchase Agreement.  It is sometimes referred to as the “haircut” approach.

Under “Method B”, “Transaction Exposure” is:

E = R – V

where:

“R” is the “Repurchase Price” at the time of calculation (in other words, the amount of the ‘loan’ plus the interest that has accrued to date); and

“V” is the “Adjusted Value” of Equivalent Securities at such time, being:

V = (MV(1-H))

where:

“MV” is the Market Value of Equivalent Securities; and

“H” is the ‘haircut’ agreed for those securities.

Bringing these two elements together, “Transaction Exposure” under “Method B” is:

E = R – (MV(1-H)).

We can expand the brackets, which results in “Transaction Exposure” under “Method B” being equal to:

E = R – (MV – (MV*H))

Considering this equation, from a high-level point of view, we are looking, first, at the amount of the ‘loan plus accrued interest’.  This is “R” – the “Repurchase Price”.  We then deduct from this amount the haircutted value of collateral held against the ‘loan’.  In doing so, we are effectively asking “does the haircutted value of the collateral exceed the current amount of the loan plus accrued interest?”

If E is GREATER than zero, then the ‘haircutted value of the collateral’ is less than the value of the ‘loan plus accrued interest’ and the Buyer (in other words, the lender) has exposure to the Seller (in other words, the borrower).  Why?  Because the amount to be repaid (“R”) EXCEEDS the haircutted value of the collateral held.

Conversely, if E is LESS than zero, then the ‘haircutted value of the collateral’ is greater than the value of the ‘loan plus accrued interest’ and the Seller (in other words, the borrower) has exposure to the Buyer (in other words, the borrower).  Why?  Because the haircutted value of the collateral held EXCEEDS the amount to be repaid.

“Method B” is considered in more detail under the definition of “Transaction Exposure”.

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