Lesson 5 of 25 · 7 min

Why a haircut widens as a position grows

The same asset carries two different discounts at two different sizes, because size is measured in exit time.

A haircut is not a property of an asset. Track 1 lesson 4 defined it as the complement of the advance rate and explained that it prices the liquidation window. The consequence nobody expects is that the identical asset carries a different haircut at a different size, in the same account, on the same day.

Schedules usually express this in tiers, applied to the position's size as a share of the pledged pool. An illustrative schedule for a single large-company holding: 70 percent on the portion up to 15 percent of the pool, 60 percent on the portion between 15 and 30 percent, and 40 percent on everything above 30 percent. Three advance rates, one holding.

Run a position through it. The pool is $1,760,000 and the holding is $704,000, which is 40 percent of the pool. The first tier covers 15 percent of $1,760,000 = $264,000 at 70 percent, giving $184,800. The second tier covers the next $264,000 at 60 percent, giving $158,400. The remainder is $704,000 − $528,000 = $176,000 at 40 percent, giving $70,400. Add them: $413,600.

Now read the result backwards. The effective advance rate is $413,600 ÷ $704,000 = 58.75 percent, so the effective haircut is 41.25 percent — against a headline rate of 70 percent and a headline haircut of 30 percent. Nothing in the schedule was hidden. The headline simply described the first slice, and the position had three slices.

A published advance rate is a marginal rate on the first slice of a position. The rate that governs your line is the average across every slice, and it falls as the position grows.

Key terms

Tiered schedule: A table assigning different advance rates to successive slices of one position, sliced by its share of the pledged pool.
Marginal advance rate: The rate applying to the next dollar of a position. It is the number usually published.
Effective advance rate: Total lending value divided by total market value for one holding. It is the number that actually governs, and it is lower than the headline whenever a tier has been crossed.

Worked example

One holding, three advance rates

Pledged pool $1,760,000. One holding worth $704,000, which is 40% of the pool. Illustrative schedule: 70% up to 15% of the pool, 60% from 15% to 30%, 40% above 30%.

First tier, $264,000: $184,800
Second tier, $264,000: $158,400
Third tier, $176,000: $70,400
Lending value on the holding: $413,600
Effective advance rate: 58.75%
Effective haircut: 41.25%

The schedule's top line said 70 percent and the holding received 58.75 percent. Both figures are correct and only one of them is operative.

Check yourself

Same schedule: 70% up to 15% of the pool, 60% from 15% to 30%, 40% above. The pool is $1,200,000 and the holding is $300,000. What is the effective advance rate on the holding?

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Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.