Factually (ie. definitions) I understand the difference fine. Conceptually, given the relationships or drivers of each, I’m struggling.
Repo Margin: the difference between market value of collateral security and the value of the loan.
It’s stated that a high quality/highly demanded collateral, drives this repo margin down, yet I struggle to understand that given the formula. You would think a high value/high demanded collateral will drive up the market value of collateral, leading to a larger repo margin. Or is this saying that the value of the loan is driven up as high as security value, thereby reducing that margin, or something?
The way that I understand it is that the collateral will always have less value than the loan. Therefore, as the quality increases and price of collateral goes up it gets closer to the value of the loan. I think of it by realizing why would a loan be taken out in the first place if the collateral is worth more? But I could be wrong cause I’m not really sure about repos
The Repo margin serves as an insurance to the lender against price decreases of the collateral asset
if the quality of the asset is high, the difference between the loan value and the market value (the “insurance premium”) does not have to be as large. The repo margin is smaller
Thanks for the help guys, but I still don’t comprehend…
@achokshi: It is stated in the text, the value of collaterall often exceeds value of the loan, to provide a buffer incase this collaterall value diminishes.
@scibus: but isn’t that difference already inherently larger b/c the market value of the collateral is already high. if equation is [market value - loan value = repo margin], and left side of that equation goes UP, how does that lend to a lower repo margin
its rather the other way around, i.e. (Loan value)/(Market Value) = repo margin… if market value goes up, the fraction gets smaller.
Before you enter a repo-agreement, the market-value is given and the loan value is determined on the basis (among others) of the asset quality of the collateral.
Ok, that makes much more sense, thank you! I suppose we do not need to know this, just the relationships given in text, and so them not providing the actual formula for it and expressing it as a “difference” was confusing me. But it would make sense that a margin, is a %, as you’re getting at. This helps me to understand the relationships much better, so much appreciated.
