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FRM Part II · FRM Exam Part II · Repurchase Agreements and Financing

A bank funds a bond portfolio through overnight repo. Regulators are concerned that in stress, lenders will sharply raise haircuts and refuse to roll the funding. Which liquidity management measure most directly addresses this rollover and haircut risk?

Lengthening repo tenor, diversifying counterparties and keeping unencumbered high-quality liquid assets best address rollover and haircut risk. Term funding reduces how often funding must be renewed, diversification limits dependence on one lender, and the buffer absorbs higher haircuts. The alternatives raise rollover or concentration risk.

  1. ALengthening the tenor of repo funding and diversifying counterparties, while holding unencumbered high-quality liquid assetsCorrect
  2. BIncreasing reliance on overnight tenors because they carry the lowest rates
  3. CPosting only the least liquid securities as collateral to preserve high-quality assets
  4. DConcentrating funding with a single large repo lender to simplify relationships

Explanation

Term funding reduces the frequency of rollover, diversification limits dependence on any lender, and an unencumbered liquidity buffer covers haircut increases. The other options increase rollover or concentration risk, and posting illiquid collateral typically attracts higher haircuts.

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