Repo agreements, haircuts, and leverage visualized
A repo haircut is the slice of the position you fund yourself. If the haircut is 5%, a $100 bond can be financed with $95 of repo cash and $5 of equity, creating 20x asset-to-equity leverage.
Funding stack
The haircut is the borrower-funded slice of the bond position. The repo lender finances the rest.
Your funding slice
The haircut requires $5.00 of your own capital to control $100.00 of collateral.
Two leverage definitions
20.0x using assets / equity; 19.0x using debt / equity.
Loss magnifier
-1.00% on the bond changes equity by -20.0% before repo interest.
Haircut to max asset leverage
The shortcut is approximately asset leverage = 1 / haircut. Lower haircuts create a steep leverage curve.
Why 5% means 20x, not always 19x
In fixed income conversation, leverage often means asset exposure divided by equity. The same balance sheet can also be described as debt divided by equity. Both are correct if the definition is stated.
The 1% move problem
Repo financing makes the debt side sticky. If the bond price falls, the repo cash owed does not fall with it. The loss comes out of equity first.
Equity return from asset moves
Before financing interest, equity return is approximately asset return divided by the haircut.
The repo flow
1. Start
Borrower owns $100.00 bond collateral.
2. Finance
Lender advances $95.00 cash against the bond.
3. Haircut
Borrower funds $5.00 equity, the haircut slice.
4. Close
Borrower repurchases for $95.0119 and receives collateral back.
Haircuts are also maintenance discipline
If collateral falls, the lender may ask for more collateral or repayment so the loan is again covered by the required haircut. The exact legal mechanics depend on the repo agreement, but the balance sheet pressure is the same.
Haircut shortcut table
The quick approximation is asset leverage equals 1 divided by the haircut. Small haircuts create very large exposure relative to equity.
| Haircut | Approx asset leverage | Equity on $100 bond |
|---|---|---|
| 1% | 100x | $1.00 |
| 2% | 50x | $2.00 |
| 5% | 20x | $5.00 |
| 10% | 10x | $10.00 |
| 20% | 5x | $20.00 |
Repo interest is separate
The haircut is capital support. The repo rate is the financing cost. On this setup, the financing cost is small over a short tenor, but it still raises the break-even asset move.
Fixed income framing
Collateralized borrowing
A repo is economically close to borrowing cash against securities collateral while agreeing to repurchase the securities later.
Haircut as lender cushion
The haircut protects the lender against market value declines, liquidity frictions, and closeout delay.
Leverage is definition-sensitive
Always check whether the context means asset / equity, debt / equity, or balance-sheet leverage under accounting rules.
Repo haircut FAQ
Is a repo haircut a fee?
No. The haircut is the portion of the collateral value that the borrower must fund with their own equity or excess collateral. Repo interest is the financing cost.
Why does a 5% repo haircut imply 20x leverage?
Using asset exposure divided by equity, $100 of collateral supported by $5 of equity is 20x. Using debt divided by equity, the $95 loan over $5 equity is 19x.
What happens when the bond price falls?
The repo debt is still owed, so the first loss hits the borrower equity. A 1% fall on a 5% haircut reduces equity from $5 to $4 before repo interest, a 20% equity loss.
Why do lenders demand haircuts?
The haircut gives the lender a cushion against collateral price moves, liquidity costs, operational delays, and counterparty default during closeout.
More visual finance concepts
Return to the concept hub as the library grows.