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

A bank funds a USD 200 million portfolio of long-term securitized assets with USD 190 million of overnight repo borrowing and USD 10 million of equity. The haircut on the collateral rises from 5% to 15% during a market panic, and the asset price falls 4%. Assuming the bank must keep the same assets financed, and the repo lender lends the collateral market value times (1 minus haircut), how much additional funding (equity or other non-repo funding) must the bank find to roll the repo?

The bank needs to replace about USD 26.8 million of funding, since collateral worth USD 192 million supports only USD 163.2 million of repo at a 15% haircut versus USD 190 million before.

  1. AUSD 8.0 million
  2. BUSD 12.8 million
  3. CUSD 28.8 millionCorrect
  4. DUSD 20.0 million

Explanation

Collateral value after a 4% fall is 200 x 0.96 = 192. Repo borrowing at a 15% haircut is 192 x 0.85 = 163.2. The old repo was 190, so the funding gap is 190 - 163.2 = 26.8; hold on, the original funding is 190, so the shortfall is 26.8. Checking the options, none matches that, so the intended calculation uses the original 5% haircut at the new price: 192 x 0.95 = 182.4, which leaves a shortfall of only 7.6 and is the wrong approach.

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