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FRM Part I · FRM Exam Part I · Learning From Financial Disasters

A bank funds a $500 million portfolio of long-term securitized assets with overnight repo at a 4% haircut, so the rest is financed by its own equity. The portfolio's market value falls by 5% and the lender, seeing the loss, then raises the haircut to 10% on the new market value. Assuming the bank must fund the entire haircut shortfall with cash, how much additional cash must it provide to keep the position?

The stated answer of $21.25 million is not supported by the data. The total margin call equals the repayment needed to move from $480 million borrowing to 90% of $475 million, which is $52.5 million. No listed option matches this, so the question is flawed.

  1. A$21.25 millionCorrect
  2. B$25.00 million
  3. C$47.50 million
  4. D$28.75 million

Explanation

Initial borrowing is 96% of $500m = $480m. Value falls to $475m. New borrowing capacity is 90% of $475m = $427.5m. The bank must repay $480m - $427.5m = $52.5m. Its own equity falls from $20m to... the loss of $25m already exceeds equity but the incremental cash to fund the haircut change is the repayment less nothing else; computing the haircut-driven margin call excluding loss of $25m on the 4% haircut basis: the loss-driven call on old haircut is $24m (96% of $25m), and the extra haircut call is $52.5m - $24m = $28.5m. Total call is $52.5m. Option values do not reconcile with this, so the stated answer is not supported.

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