Lesson 15 of 25 · 6 min

A concentration limit that binds only in a drawdown

A cap on one holding's share of the total can be breached by the other holdings falling instead.

A concentration limit is usually read as a rule about acquiring too much of one thing. It is a rule about a ratio, and a ratio can change from either end.

As written, the rule says that no single holding may contribute more than a stated share of total lending value, and anything above that share is not counted. The denominator is the whole pledged book, so it moves when any holding moves and when any advance rate is revised. The numerator can sit perfectly still while the ratio climbs through the limit.

Four holdings, illustratively. At the start they produce $1,428,000 of lending value, of which the largest contributes $564,000, or 39.5 percent — inside a 40 percent cap. Then the other three both fall and are revised: the second loses 26 percent of its price and goes from a 70 percent advance rate to 58, the third loses 31 percent and goes from 50 to 35, the fourth loses 9 percent and goes from 75 to 72. The largest does not move at all.

Total lending value is now $1,125,679 and the unchanged holding contributes 50.1 percent of it. The cap allows 40 percent of that, which is $450,271.60, so $113,728.40 is disallowed and total lending value falls to $1,011,950.60. The holding that lost $113,728.40 of credit is the one whose price, row and advance rate were exactly what they were the day before.

A ratio has two ends, and a limit written on a ratio can be breached from the end you are not watching.

Key terms

Concentration limit: A cap on how much of an account's total lending value one holding may supply. Stated as a share, so everything else affects it.
Contribution share: One holding's lending value divided by the account's total. It rises when the holding rises and equally when the rest of the account falls.
Disallowed excess: The portion of a holding's lending value above the cap, which is simply not counted. The holding is still owned and pledged.

Worked example

Punished for not falling

Illustrative figures. Four holdings, a 40 percent cap, and a decline that touches three of them.

Lending value at the start: $1,428,000
Largest holding's share at the start: 39.50%
The other three after price falls and revisions: $266,104, $99,015, $196,560
New total before the cap: $1,125,679
Its share now: 50.10%
Disallowed: $113,728.40

One holding lost 20 percent of its lending value without its price, its row or its rate changing at all.

Check yourself

An account has $890,000 of lending value, $320,000 of it from one holding, against a 38 percent cap. The other holdings fall until total lending value is $742,000, while that holding is unchanged. What happens?

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.