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FRM Part I · FRM Exam Part I · Anatomy of the Great Financial Crisis of 2007-2009

A bank has assets of USD 100 million and equity of USD 5 million. A 1% decline in asset values lowers equity to USD 4 million, and assets become USD 99 million. To restore the original leverage of 20 times, with no new equity, the bank sells assets and repays debt. What is the required asset sale?

The bank must sell USD 19 million of assets. Restoring leverage of 20 with equity of USD 4 million requires assets of USD 80 million, and current assets are USD 99 million. The sale is the difference, which shows how a small shock forces large procyclical deleveraging.

  1. AUSD 19 millionCorrect
  2. BUSD 20 million
  3. CUSD 1 million
  4. DUSD 4 million

Explanation

Target assets = 20 x 4 = 80 million. Current assets are 99 million, so the sale is 99 - 80 = 19 million. Choosing 20 million ignores the 1 million markdown already taken; choosing 1 million only counts the loss.

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