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Simple English definitions for legal terms
haircut
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A quick definition of haircut:
A haircut is a term used in finance that refers to the discount or reduction in the value of an asset. For example, if a brokerage firm holds stock in its own account, it may be required to take a haircut on the value of that stock when reporting its net capital condition. Similarly, when someone takes out a loan and uses an asset as collateral, the difference between the loan amount and the market value of the collateral is known as a haircut.
A more thorough explanation:
Definition: A haircut is a term used in finance and securities regulation to refer to the discount or reduction in value applied to an asset or security when it is used as collateral for a loan or held by a brokerage firm.
Example 1: In securities regulation, a brokerage firm is required to report its net capital condition on a monthly basis. As part of this report, the firm must apply a haircut to the value of any stock it holds in its own account. This means that the reported value of the stock will be lower than its actual market value, reflecting the risk associated with holding the stock as collateral.
Example 2: A borrower may offer a piece of property as collateral for a loan. The lender will typically apply a haircut to the value of the property, meaning that the loan amount will be less than the market value of the property. This is done to protect the lender in case the borrower defaults on the loan and the property needs to be sold to recover the debt.
These examples illustrate how a haircut is used to reduce the value of an asset or security in order to account for the risk associated with holding it as collateral or as part of a brokerage firm's own account. By applying a haircut, lenders and brokerage firms can protect themselves from potential losses and ensure that they have sufficient capital to meet their obligations.