Post on 06-Apr-2018
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MARGINING
Karthik Reddy. PInstitute of Public Enterprise
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FLOWOFPRESENTATION
Introduction - Margin
Types of margins.
VaR margin
Extreme loss margin Mark to market margin
Margins in futures and options segment
Margin call
Conclusion
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INTRODUCTION
In stock markets there is always an uncertainty in the
movement of share prices.
This uncertainty leading to risk is sought to be addressed
by margining systems by stock markets.
Suppose an investor, purchases 1000 shares of xyz
company at Rs.100/- on January 1, 2008. Investor has to
give the purchase amount of Rs.1,00,000/- (1000 x 100) to
his broker on or before January 2, 2008. Broker, in turn, has
to give this money to stock exchange on January 3, 2008.
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Investor pays a portion of total amount to the broker at thetime of placing the order. This initial token is calledmargin.
In the above example, assume that margin was 15%. That isinvestor has to give Rs.15,000/-(15% of Rs.1,00,000/) to thebroker before buying. Now suppose that investor bought theshares at 11 am on January 1, 2008. Assume that by the end
of the day price of the share falls by Rs.25/-. That is totalvalue of the shares has come down to Rs.75,000/-. That isbuyer has suffered a notional loss of Rs.25,000/-. In ourexample buyer has paid Rs.15,000/- as margin but thenotional loss, because of fall in price, is Rs.25,000/-. That is
notional loss is more than the margin given.
Margin payments ensure that each investor is serious aboutbuying or selling shares.
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MARGIN - TYPES
SEBI has prescribed different way to margin cash and
derivatives trades taking into consideration unique features
of instruments
Margins in the cash market comprises of the following:
Value at risk (VaR) margin
Extreme loss margin Mark to market margin
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VaR is a technique used to estimate the probability of loss of
value of an asset or group of assets based on statistical price
trends.
A VaR statistic has three components, a time period, a
confidence interval and a loss amount.
For example, consider shares of a company bought by an
investor. Its market value today is Rs.50 lakhs but its market
value tomorrow is obviously not known. An investor holdingthese shares may, based on VaR methodology, say that 1-day
VaR is Rs.4 lakhs at 99% confidence level.
This implies that under normal trading conditions the
investor can, with 99% confidence, say that the value of theshares would not go down by more than Rs.4 lakhs within
next 1-day.
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Extreme loss margin aims at covering the losses that could
occur outside the coverage of VaR margins.
The Extreme loss margin for any stock is higher of 1.5 timesthe standard deviation of daily LN returns of the stock price
in the last six months or 5% of the value of the position.
If in the Example the VaR margin rate for shares of ABC Ltd.was 13%. Suppose the 1.5 times standard deviation of daily
LN returns is 3.1%. Then 5% (which is higher than 3.1%)
will be taken as the Extreme Loss margin rate.
Therefore, the total margin on the security would be 18%(13% VaR Margin + 5% Extreme Loss Margin). As such,
total margin payable (VaR margin + extreme loss margin) on
a trade of Rs.10 lakhs would be 1,80,000/-.
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Mark to market is calculated at the end of the day on all
open positions by comparing transaction price with the
closing price of the share for the day.
In the above example, we have seen that a buyer purchased
1000 shares @ Rs.100/- at 11 am on January 1, 2008. If
close price of the shares on that day happens to be Rs.75/-,then the buyer faces a notional loss of Rs.25,000/ - on his
buy position. In technical terms this loss is called as MTM
loss.
MTM Profit/Loss = [(Total Buy Qty X Close price) - Total BuyValue] - [Total Sale Value - (Total Sale Qty X Close price)]
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MARGINSINFUTURESANDOPTIONSSEGMENT
In order to cover default risks, future exchanges prescribe
the margins to be kept by both parties in a contract.
Therefore, every trader should deposit some amount before
the execution of transaction. This amount is called as initial
margin or initial performance bond.
The initial margin is a certain percentage of a futures
contract value.
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The balance in the margin account should never be negative.
In order to ensure that, another kind of margin, known as
maintenance margin or maintenance performance bond isprescribed.
Whenever, the balance in the margin account falls below the
maintenance margin, the investor would receive a margincall, also known as Performance bond call
Then, the additional funds are deposited to bring the account
back up to initial margin. This is known as Variation
margin.
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MARGIN CALL
Margin call can be better understood from the following
example.
Assume, the initial margin on a futures contract is INR
10,000 and the maintenance margin is INR 7,500.
In the process of marking to market, the value of the
margin account of the investor has dropped to INR 4,000.
Then, the investor receives a margin call. so, the investor
has to deposit at least an additional INR 6,000 to bring theaccount back up to initial margin level of INR 10,000. this
additional fund (6,000) is variation margin.
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The trading transactions on a futures exchange are done
through the members of the exchange clearing house.
The members of clearing house are required to maintain
margin accounts with the clearing house. Such margins are
known as clearing margins.
The minimum levels for initial and maintenance margins
are fixed by future exchanges.
CME uses a computerized risk management program called
SPAN to decide on margin requirements.
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Margin requirements vary based on the type of traders,
hedgers or speculators.
Securities like treasury bills are also accepted as initial
margin, but the maintenance margins are generally in cash
only.
The SPAN margins are revised six times a dayonce at the
beginning of the day, 4 times during market hours and once at
the end of the day.
In addition to the initial margin, a Premium margin is charged
to trading members trading in options contracts.
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The premium margin is paid by the buyers and is equal to
the values of the options premium multiplied by the quantity
of options purchased.
For example, if 1000 call options on ABC Ltd are purchased
at Rs. 20/-, and the investor has no other positions, then the
premium margin is Rs. 20,000.
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CONCLUSION
The whole purpose of the margining system is to reduce
the possibility of market participants sustaining lossesbecause of defaults.
Losses arising from defaults in contracts at major
exchanges have been almost non existent
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Thank you