50.1K

Verified Solution

Link Copied!

Introduction

Broker-dealers are required to maintain a certain minimum amount of net capital. The first step in calculating a firm's net capital is to determine the firm's total capital. To then compute net capital, one must take charges against total capital to account for the inherent risk of positions held. These charges are called 'haircuts'. Technically, a haircut is defined as "a percentage that is subtracted from the par value of the assets that are being used as collateral. The size of the haircut reflects the perceived risk associated with holding the assets."

We're going to determine the haircuts in some hypothetical situations.

Part I: Currencies

There is a separate haircut calculated for each foreign (i.e., non-USD) currency. The first thing we need to do to calculate the haircut on a given currency is to figure out the firm's total exposure to that currency. A negative currency position indicates that the firm is short (or owes) the currency. There are two ways the accompanying spreadsheet will show currency exposure:

1) Actual cash is denoted 'cash' in the Position Symbol column, and can be in a variety of different currencies. You can see the symbol for the currency of the cash in the Currency column (EUR = Euro, GBP = British Pound, BRL = Brazilian Real, USD = US Dollar). The USD value of the cash is shown in the Market Value (USD) column. There may be several cash lines for the same currency due to the positions being in different accounts.

2) We also have forwards. A forward is an agreement to buy a currency in the future. For risk purposes, it is essentially the same as actually owning the currency. So if we show a 'Forward EUR' position with a market value in USD, this is the same (for risk and haircut purposes) as if we had 'cash' with 'EUR' in the Currency column.

Add up the pieces to get to the total exposure for a currency, and apply a haircut to the absolute value of that total exposure. If the firm is long and short the same currency (whether in cash or forwards), the total currency risk is the net position in that currency.

The haircut for GBP and EUR is 6%, while the haircut for ZAR and BRL is 20%. There is no haircut for USD positions.

What is the total haircut in USD on the positions in the accompanying spreadsheet?

Part II: Bonds

1. Municipal Bonds - Municipal bonds are haircut per Exhibit 1 based on both their time to maturity and scheduled maturity at date of issue. The bond details can be found on the Bonds & Ratings Information tab in the spreadsheet.

2. Corporate Bonds - Corporate bonds are haircut based on both their time to maturity and whether they are rated as investment grade (defined by S&P and Fitch as BBB- and above and by Moody's as Baa3 and above)[1] by at least two of the nationally recognized statistical rating organizations. If the bonds qualify as investment grade, use Exhibit 2 to determine the haircut of the bonds. If they do not qualify as investment grade, then they are considered non-marketable and follow the haircut rules as stated in Exhibit 3.

It is important to note that the haircut is calculated using the absolute value of the market value of the relevant bond.

What is the total haircut in USD on the positions in the accompanying spreadsheet as of 2017-12-31?

[1] In Exhibit 2, the text references "one of the four highest ratings categories". The four highest ratings categories for S&P and Fitch are AAA, AA, A, and BBB. The four highest ratings categories for Moody's are Aaa, Aa, A, and Baa. The plus/minus signs and numbers next to the ratings are used for increased specificity within the ratings categories.

Exhibits:

EXHIBIT \#1 (c)(2) Definitions: Net Capital (Continued) (vi) SECURITIES HAIRCUTS (Continued) (B) MUNICIPALS (1) In the case of any municipal security which has a scheduled maturity at date of issue of 731 days or less and which is issued at par value and pays interest at maturity, and which is not traded flat or in default as to principal or interest, the applicable percentages of the market value on the greater of the long or short position in each of the categories specified below are: (i) Less than 30 days to maturity .0% (ii) 30 days but less than 91 days to maturity. 1/8 of 1% (iii) 91 days but less than 181 days to maturity.........1/4 of 1% (iv) 181 days but less than 271 days to maturity........3/8 of 1% (v) 271 days but less than 366 days to maturity........1/2 of 1% (vi) 366 days but less than 456 days to maturity........3/4 of 1% (vii) 456 days but less than 732 days to maturity. 1% (2) In the case of any municipal security, other than those specified in paragraph (c)(2)(vi)(B)(1), which is not traded flat or in default as to principal or interest, the applicable percentages of the market value of the greatest of the long or short position in each of the categories specific below are: (i) Less than 1 year to maturity. .1% (ii) 1 year but less than 2 years to maturity .2% (iii) 2 years but less than 321 years to maturity. .3% (iv) 321 years but less than 5 years to maturity. .4% (v) 5 years but less than 7 years to maturity. .5% (vi) 7 years but less than 10 years to maturity. .5121% (vii) 10 years but less than 15 years to maturity. .6% (viii) 15 years but less than 20 years to maturity 61/21% (ix) 20 years or more to maturity. .7% EXHIBIT \#2 (c)(2) Definitions: Net Capital (Continued) (vi) SECURITIES HAIRCUTS (F) NONCONVERTIBLE DEBT SECURITIES (1) In the case of nonconvertible debt securities having a fixed interest rate and a fixed maturity date and which are not traded flat or in default as to principal or interest and which are rated in one of the four highest rating categories by at least two of the nationally recognized statistical rating organizations, the applicable percentages of the market of the greater of the long or short position in each of the categories specific below are: (i) Less than 1 year to maturity. .2% (ii) 1 year but less than 2 years to maturity. .3% (iii) 2 years but less than 3 years to maturity. .5% (iv) 3 years but less than 5 years to maturity. 6% (v) 5 years but less than 10 years to maturity. .7% (vi) 10 years but less than 15 years to maturity.......7 121% (vii) 15 years but less than 20 years to maturity. .8% (viii) 20 years but less than 25 years to maturity. .8121% (ix) 25 years or more to maturity .9% (2) A broker or dealer may elect to exclude from the above categories long or short positions that are hedged with short or long positions in securities issued by the United States or any agency thereof or nonconvertible debt securities having a fixed interest rate and a fixed maturity date and which are not traded flat or in default as to principal or interest and which are rated in one of the four highest rating categories by at least two of the nationally recognized statistical rating organizations if such securities have maturity dates: (i) Less than five years and within 6 months of each other, (ii) Between 5 years and 10 years and within 9 months of each other, (iii) Between 10 and 15 years and within 2 years of each other; or (iv) 15 years or more and within 10 years of each other. EXHIBIT \#3 (c)(2) Definitions: Net Capital (Continued) (vii) NON-MARKETABLE SECURITIES (Continued) /09 Marketability of Money Market Instruments (Continued) Note: For purpose of this interpretation 15c31(c)(2) (vii)/09 only, major money markets include: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Italy, Japan, Luxembourg, Mexico, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, United States and United Kingdom /10 Marketability of Nonconvertible Debt Securities Which Are Not Highly Rated The SEC Division of Market Regulation will not recommend enforcement action to the Commission if broker-dealers apply the haircuts described below to nonconvertible debt securities held in their proprietary accounts which are not rated in one of the four highest rating categories by at least two NRSROs provided the following conditions are met: 1. The securities can be publicly sold without registration with the Commission under Section 5 of the Securities Act of 1933, and 2. Current information concerning the issuer is available to the public. Current information is deemed to be available to the public if: a. The issuer filed with the Commission public reports consisting of the most recently required periodic financial report, or b. The issuer (provided it is the subject of a bankruptcy proceeding) filed with a bankruptcy court, public information that is sufficient to value the assets and liabilities of the issuer and such information is dated not more than six months prior to the date of the brokerdealer's capital computation. The current information requirement will also be deem to be satisfied by the existence of current ratings by two NRSROs on any issuance of the issuer. A rating by an NRSRO is considered to be current if the NRSRO itself continues to hold out its rating for the issuance of the issuer. Non-investment grade nonconvertible debt securities shall be treated as follows: 1. The broker-dealer shall deduct from its net worth the following percentages applied to the greater of the gross long or the gross short market value of non-investment grade, nonconvertible debt securities' positions in each of the categories specified below: a. An initial issuance of at least $100 million. b. An initial issuance of at least $75 million and less than $100 million........20\% c. An initial issuance of at least $50 million and less than $75 million..........25\% d. An initial issuance of at least $20 million and less than $50 million.........50\% e. An initial issuance of less than $20 million or have been held in inventory for more than 90 days as the result of the failure to complete an underwriting. 100% Broker-dealers may not include the value of non-investment grade, nonconvertible debt securities, subject to the haircut percentages set forth above, in paragraph (c)(2)(vi)(J) of Rule 15c3-1 for the purpose of netting long or short securities positions under paragraph (c)(2)(vi)(J). 2. The broker-dealer shall take an additional portfolio concentration charge on the securities in categories (b), (c) and (d) above, to the extent the market value of the greater of the gross total long or gross total short positions in categories (b), (c) and (d) combined exceeds 25 percent of the broker-dealer's tentative net capital. The portfolio concentration charge shall be 50 percent of the haircuts otherwise taken on that portion of the total market value of the securities in categories (b), (c) and (d) in excess of 25 percent of tentative net capital. This portfolio concentration charge may be reduced by any undue concentration charge computed in accordance with paragraph (c)(2)(vi)(M) of Rule 15c31. Securities with an initial issuance of less than $20 million will be deemed to be included in category (d) above if the issuer has another outstanding issue of non-investment grade, nonconvertible debt securities, which has an initial issuance of $50 million or more. Rule 144A debt securities are not deemed to have a ready market pursuant to this interpretation since they cannot be publicly sold. (SEC Letter to SIA, February 14, 1994) (No. 94-5, May, 1994) (No. 97-6, October 1997) \begin{tabular}{|c|l|l|r|r|} \hline & \multicolumn{1}{|c|}{ A } & \multicolumn{1}{|c|}{ B } & \multicolumn{1}{c|}{ C } & \multicolumn{1}{c|}{ D } \\ \hline 1 & ticker & direction & quantity & price \\ \hline 2 & YHOO US & B & 100 & 18.73 \\ \hline 3 & YHOO US & B & 20 & 18.8 \\ \hline 4 & C US & S & 200 & 34.56 \\ \hline 5 & YHOO US & B & 100 & 18.61 \\ \hline 6 & FB US & S & 200 & 27.39 \\ \hline 7 & BAC US & B & 100 & 9.81 \\ \hline 8 & AAPL US & S & 50 & 589.01 \\ \hline 9 & ORCL US & S & 100 & 32.39 \\ \hline 10 & ORCL US & S & 200 & 32.349 \\ \hline 11 & BAC US & B & 444 & 9.825 \\ \hline 12 & C US & S & 200 & 34.28 \\ \hline 13 & GRPN US & B & 400 & 4.12 \\ \hline 14 & BAC US & B & 100 & 9.79 \\ \hline 15 & FB US & B & 100 & 27.75 \\ \hline 16 & FB US & B & 100 & 27.12 \\ \hline 17 & BAC US & S & 15 & 9.81 \\ \hline 18 & AAPL US & S & 25 & 589.08 \\ \hline 19 & EBAY US & B & 100 & 52.62 \\ \hline 20 & YHOO US & S & 400 & 18.62 \\ \hline 21 & AAPL US & B & 100 & 589.05 \\ \hline 22 & AAPL US & S & 10 & 589.08 \\ \hline 23 & BAC US & S & 17 & 9.8 \\ \hline \end{tabular} 1) Count the number of trades that are buying YHOO US? 2) Count the number of trades that are selling YHOO US? 3) How many shares of GRPN US were traded on the day? 4) What is the total market value of all the trades that are buying BAC US? 5) What is the volume-weighted average price of all buys in FB US

Answer & Explanation Solved by verified expert

See Answer