In computing net capital, a broker-dealer removes some assets from the calculation entirely and applies a percentage deduction to others. What distinguishes an asset treated as non-allowable from one that is merely subject to a haircut?
- A.A non-allowable asset cannot readily be converted into cash, while a haircut asset can be but may lose value first.Correct. The rule sorts assets first by liquidity, then applies a price-risk deduction to what survives that sort.
- B.A non-allowable asset is owned outright by the firm, while a haircut applies to assets pledged to a lender.Wrong. Encumbrance affects how much value a firm may claim, but it is not the line the rule draws between the two treatments.
- C.A non-allowable asset belongs to customers, while a haircut applies to the firm's proprietary positions.Wrong. Customer property is addressed by the custody and reserve requirements, not by the non-allowable classification.
- D.A non-allowable asset is carried at book value, while a haircut applies to assets carried at market.Wrong. The accounting basis on which an asset is carried is a bookkeeping question, not the test the net capital rule applies.
Why: The net capital rule is a liquidity test rather than a solvency test. It begins from net worth, adds back qualifying subordinated liabilities, and then strips out assets that cannot be turned into cash quickly, such as furniture and fixtures, unsecured receivables and prepaid expenses, on the reasoning that a firm winding down cannot pay customers with them. What survives that filter is largely marketable, but market value can move before a position is sold, so the rule then deducts a haircut from those positions to allow for price risk. The two deductions answer different questions: whether the asset can be converted to cash at all in the time available, and if so, how much of its value might evaporate first.