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FRM Part II · FRM Exam Part II · Managing Nondeposit Liabilities

A bank funds a 100 million Treasury position with overnight repo at a 5% haircut, so it borrows 95 million and funds the 5 million balance with equity. Overnight repo costs 4.00% and the position yields 4.60% (actual/360 ignored; use annual rates). The repo rate then rises by 50 bps. By how much does the annual net carry income on the position change, and in what direction?

Net carry falls by 475,000 a year. Only 95 million is financed in repo, so the 0.50% rate rise adds 475,000 to funding cost, while the asset yield is unchanged. Applying the increase to the full 100 million would wrongly give 500,000.

  1. AFalls by 475,000Correct
  2. BFalls by 500,000
  3. CFalls by 50,000
  4. DRises by 475,000

Explanation

Initial carry: asset income 4.60 million minus repo cost 95 million x 4% = 3.80 million, net 0.80 million. After the rise, cost is 95 million x 4.50% = 4.275 million, net 0.325 million. The change is a fall of 475,000. Applying 50 bps to 100 million gives 500,000, ignoring that only 95 million is borrowed.

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