Equity Markets

A QUALITY E-LEARNING PROGRAM BY WWW.LEARNWITHFLIP.COM

Chapter Name: Risk Management

Exchanges manage risk by imposing margins on the broker members.

Margins in the cash market segment comprise the following three types:

• Value at Risk margin

• Extreme Loss margin
• Mark to Market margin

Value at Risk (VaR) margin

A VaR Margin is a margin intended to cover the maximum probable loss (in %) that may be faced
by an investor on a single day with a 99% confidence level.

To compute VaR, we need to first calculate the past returns of the stock & ‘volatility’. Past returns are
computed as follows:

Pls paste the formula from slide 6

The ‘volatility’ per day is given by the standard deviation of the returns.

Volatility can also be computed using the EWMA methodology.

Pls paste the formula

The Var margin is then computed as follows:

• For Group I shares, the VaR margin rate would be the higher of:

9 3.5 times volatility or

9 7.5% of value of the transaction.

• For Group II shares, the VaR margin rate would be the higher of:

9 3.5 times volatility or

9 3 times the VaR of the index*√3.

• For Group III shares, the VaR margin rate would be equal to:

9 5 times the VaR of the index*√3.

The VaR margin is collected on the gross open position of the member. The gross open position for this
purpose would mean the gross of all net positions across all their clients including their own open
(proprietary) position.

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 Equity Markets
A QUALITY E-LEARNING PROGRAM BY WWW.LEARNWITHFLIP.COM

Extreme Loss Margin

The Extreme loss margin for any stock is higher of :

• 1.5 times the standard deviation of daily returns of the stock price in the last six months.
• 5% of the value of the position.

MTM Margin

Profit or Loss also called Mark to Market (MTM) is calculated at the end of the day on all open positions.
This is done by comparing the transaction price with the closing price of the share for the day.

The MTM loss if any is payable before the market opens the next day. This is the MTM margin.

Trading Limits

Besides the margins imposed by the exchange, institutions trading in equities, also impose internal limits
on the individual traders for their proprietary trading portfolio. These are called market risk limits.

This can be classified into:

™ Position Limits

™ Loss Limits

Position limits describe the maximum net open position a trader can have in his equities portfolio.
This could be a limit on an individual stock or on the portfolio as a whole.
Loss limits describe the maximum loss a trader can incur on a single day.

©Finitiatives Learning India Pvt. Ltd. (FLIP), 2010. Proprietary content. Please do not misuse!