Lesson 7 of 25 · 7 min

Why the blended advance rate hides the concentrated position

One weighted average can describe two accounts whose collateral responds to a single event six times differently.

A blended advance rate is total lending value divided by total market value. It is a weighted average, and weighted averages destroy information about dispersion. Two accounts can print the same blended rate and behave nothing alike.

Both accounts below hold $1,850,000 and blend to exactly 64 percent, giving lending value of $1,184,000 each. Account A holds twenty-five names of $74,000 apiece, each at 64 percent. Account B holds one name worth $740,000 at 40 percent, giving $296,000, plus a broad equity index fund worth $1,110,000 at 80 percent, giving $888,000. Sum: $296,000 + $888,000 = $1,184,000, and $1,184,000 ÷ $1,850,000 = 64 percent.

Now apply one company event. A single holding falls 45 percent. In account B that is the $740,000 name losing $333,000 of market value, and lending value falls by $333,000 × 0.40 = $133,200. In account A it is one $74,000 name losing $33,300, and lending value falls by $33,300 × 0.64 = $21,312. Same event, same blended rate, and $133,200 ÷ $21,312 = 6.25 times the damage.

Notice the direction of the surprise. The concentrated account's single name carried the lower advance rate of 40 percent, which cushions the lending-value loss slightly; the damage is larger anyway, because the exposure is 10 times the size and the advance rate only differs by a factor of 1.6. A low advance rate on a large position is not a substitute for the position being smaller.

The blended rate summarises the collateral you have. It says nothing about how much of that collateral one piece of news can move, and that is the question a concentrated pledge turns on.

Key terms

Blended advance rate: Total lending value divided by total market value across everything pledged. A single weighted average.
Dispersion: How unevenly value is spread across holdings. Two pools with the same average can have completely different dispersion.
Single-event sensitivity: How much lending value one company's news can remove. It depends on position size, not on the blended rate.

Worked example

Same blended rate, one event, two outcomes

Two pledged accounts, each $1,850,000 of market value, each blending to 64%. A holds twenty-five names of $74,000 at 64%. B holds one name of $740,000 at 40% plus $1,110,000 of a broad index fund at 80%. One name falls 45%.

Lending value, account A: $1,184,000
Lending value, account B: $1,184,000
A's loss of lending value: $21,312
B's loss of lending value: $133,200
Ratio: 6.25 times

The blended rate was identical to the decimal point, and one account lost six and a quarter times as much collateral from the same headline.

Check yourself

Account B above holds a $740,000 name at a 40% advance rate. Account A holds that same company as one of twenty-five $74,000 positions at 64%. The company falls 45%. Which account loses more lending value, and why is the lower advance rate no help?

Saved in this browser only. No account, nothing sent anywhere.

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.