Risk rate

A risk rate is the parameter a broker and a clearing house use to express a potential adverse move in an instrument's price, and from which they calculate the required collateral. The rate is multiplied by the value of the position, and the result is the amount of the client's own funds that must back a leveraged trade. It is not an assessment of the security itself but of how fast and how far its price can move over the time it would realistically take to close the position.

What determines the level

The main input is the observed price dispersion: the wider the instrument's price swings (volatility), the higher the rate. Another input is whether the position can be exited without giving ground on price. If the position is large relative to normal turnover, the model builds in a buffer for the entire period needed to sell it down (liquidity horizon). The logic is akin to estimating losses with VaR: the aim is to find the price change that is unlikely to be exceeded during the time it takes to close out. A single instrument usually has several rates: an initial rate, at which a position may be opened, and a minimum rate, a breach of which triggers forced liquidation. Long and short positions are calculated separately, and a short position may be collateralised differently from a long one, because its loss has no upper limit. The client's status also affects which set of rates applies: for a qualified investor it may be broader, but the calculation mechanism itself is the same.

Example: turnover and the rate

Because the rate rests on liquidity, the exchange's most heavily traded securities almost always sit at the lower end of the risk-rate scale:

In such securities a position can be closed within a single trading session, so the buffer needed for a sell-down is small. For a thinly traded third-tier stock, the same model produces a noticeably higher rate, up to and including a ban on buying on margin.

What the rate does not measure

A common mistake is to read the risk rate as the probability of losing money. It reflects short-term price movement, not the issuer's solvency, and has nothing to do with assessing the probability of default. A low rate does not make a security calm: without leverage, the loss on it can be just as large; it simply does not require collateral. The rate is also meaningless where no leverage is used at all: on an account without borrowed funds it limits nothing and remains a reference figure in the trading terminal.