when collateral is being pledged the degree of the haircut is determined by the amount of associated risk to the lender these risks include any variables that may affect the value of the collateral in the event that the lender has to sell the security due to a loan default by the borrower variables that may influence that amount of a haircut include price volatility credit quality of the asset s issuer if applicable and liquidity risks of the collateral 
determining haircut amountgenerally speaking price predictability and lower associated risks result in compressed haircuts as the lender has a high degree of certainty that the full amount of the loan can be covered if the collateral must be liquidated for example treasury bills are often used as collateral for overnight borrowing arrangements between government securities dealers which are referred to as repurchase agreements repos in these arrangements haircuts are negligible due to the high degree of certainty on the value credit quality and liquidity of the security securities that are characterized by volatility and price uncertainty have larger haircuts when used as collateral for example an investor seeking to borrow funds from a brokerage by posting equity positions to a margin account as collateral can only borrow 50 of the value of the account due to the lack of price predictability which is a haircut of 50 while a 50 haircut is standard for margin accounts a risk based haircut can be increased if the deposited securities pose liquidity or volatility risks for example the haircut on a portfolio of leveraged exchange traded funds etfs which are highly volatile may be as high as 90 penny stocks which pose potential price volatility and liquidity risks typically cannot be used as collateral in margin accounts different lenders will have different haircut valuations if you re not satisfied with how much value your collateral is being assigned consider evaluating the terms of other financial institutions haircut market maker spreadsa haircut is also sometimes referred to as the market maker s spread since market makers can transact with razor thin spreads and low transaction costs they can take small slivers or haircuts of profits or losses constantly throughout the day with advances in technology and markets becoming more efficient spreads in many assets have dropped to haircut levels retail traders can transact at the same spreads market makers do although retail traders costs are still higher which may make trading the spread ineffective in a stock both retail traders and market makers can buy and sell for a 0 01 spread in an active and liquid stock but buying and selling 500 shares to make 5 500 0 01 when each trade typically costs 5 to 10 varies by broker is not a profitable strategy for the retail trader long term capital management s ltcm failure and collateral haircuts exampleltcm was a hedge fund started in 1993 by 1998 it had amassed massive losses nearly resulting in a collapse of the financial system the basis of ltcm s profit model which worked very well for a while was to suck up small profits from market inefficiencies this is commonly called arbitrage the firm used historical models to highlight opportunities and then deployed capital to profit from them each opportunity typically only produced a small amount of profit so the firm utilized leverage or borrowed money in order to increase the gains the firm had 5 billion in assets yet controlled over 1 trillion worth of positions in the fall of 2018 14 banks and brokerage firms invested 3 6 billion in ltcm to prevent the imminent collapse of the hedge fund 1banks and other institutions allowed ltcm to borrow or leverage so much with little collateral mainly because they viewed the firm and their positions as non risky ultimately though the firm s model failed to predict inefficiencies accurately and those massively sized positions began to lose far more money than the firm actually had and more money than many of the banks and institutions that lent to them or allow them to purchase assets had the failure of ltcm which required a bailout of the financial system resulted in much higher haircut rules in terms of what can be posted as collateral and how much the haircut has to be ltcm had basically no haircuts yet today an average investor buying regular stocks is subject to a 50 haircut when using those stocks as collateral against the amount borrowed on a margin trading account market maker haircut examplein many markets the market maker s spread is the same as the retail trader s spread although the trading costs for the retail trader make trying to profit from a haircut spread ineffective one market where retail traders often cannot trade at the same spreads as the market makers is the forex market this is because forex brokers often mark up the spread which is how they make money in the eur usd forex pair the raw spread available to market makers is 0 00001 yet retail traders may be paying a spread of 0 00005 to 0 00015 or even higher a mark up of five to 15 times the raw spread forex brokers that provide raw spreads to their clients charge a commission on each trade they make their money off of trading fees instead of marking up the spread 