Exhaust prices are discounted prices extended by a broker when there is a need to liquidate the equity position of a client. This type of situation typically occurs when the client has used the position to fund a purchase made on margin and is unable to maintain the margin or supply the funds necessary to settle the position. The actual amount of the exhaust price is usually set at an amount that will at least cover the balance due on the margin.
In most cases, exhaust prices are extended because an investor needs to settle a purchase that was bought on margin. Buying on margin is essentially a loan that the broker extends to a client, allowing that client to move forward with the purchase of a given investment. In situations where the acquired investment performs according to expectations, there is usually no trouble repaying the broker in a timely manner. This strategy that makes it possible for the investor to use his or her margin account for another investment deal.
Should the security purchased on margin fail to perform as projected, there is a good chance that a margin call will be issued. This creates a situation in which the investor does not realize the anticipated return, and is left with the responsibility of settling the outstanding debt with the broker. If the investor does not have the resources to settle the amount, or does not wish to maintain the margin in hopes that the security will eventually yield a desirable return, discussion on viable exhaust prices will ensue.
The goal of exhaust prices is to allow the broker to recover the funds loaned on margin to help the investor create the equity position. In order to recoup the balance due on that loan, the broker will determine a schedule of discounted prices for that position, and seek to obtain the highest of those prices. The schedule of exhaust prices is based on the remaining balance due on the equity position, although depending on market conditions it may be possible to sell the position for slightly more.
One of the main benefits of creating exhaust prices is that the discounted pricing increases the chances of being able to successfully liquidate the equity position that the investor is not able to maintain. By liquidating the debt, the broker not only recoups the funds extended to help the investor create the original transaction, but also aids the investor in preventing a default on the debt instrument. As a result, the brokerage is not out any funds, and the investor does not have a record of defaulting on a margin loan on his or her investment record.