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

A bank has a USD 500 million overnight repo funded by a general collateral pool, rolling daily with a money fund. In a stress event, the lender stops rolling for lower-quality collateral while still lending against Treasuries. Which action best reduces the bank's rollover risk from this source?

The best response is to lengthen repo tenors, diversify lenders and hold unencumbered high-quality liquid assets as a buffer. This reduces dependence on daily rollover and lets the bank obtain funding even when lenders stop accepting lower-quality collateral.

  1. ALengthen repo tenors and diversify lenders, while holding a buffer of unencumbered high-quality liquid assetsCorrect
  2. BShift to funding illiquid assets with shorter overnight repo to reduce interest costs
  3. CConcentrate repo with one lender to negotiate a lower haircut
  4. DPost more of the lowest-quality collateral first to preserve Treasuries

Explanation

Rollover risk is reduced by term-out, lender diversification and keeping unencumbered high-quality collateral to access funding when others withdraw. Concentration raises dependence on one lender, and funding illiquid assets overnight raises the mismatch. Posting weak collateral first leaves it more exposed to run-off.

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