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FRM Part II · FRM Exam Part II · Managing Nondeposit Liabilities

A bank has USD 500 million of loans pledged to its FHLB with a 20% haircut, supporting advances of USD 380 million. A market shock lowers the fair value of the pledged loans by 10% and the FHLB raises the haircut to 25%. Assuming collateral value is reduced first by the price fall and then haircut applied, what is the result?

The bank faces a USD 42.5 million shortfall. Collateral falls to USD 450 million after the 10% price drop, and the 25% haircut gives lendable value of USD 337.5 million, which is below the USD 380 million of advances, so extra collateral or repayment is required.

  1. AShortfall of USD 42.5 millionCorrect
  2. BExcess of USD 20 million
  3. CShortfall of USD 5 million
  4. DShortfall of USD 25 million

Explanation

Wait-check: before the shock lendable value = 500 x 0.8 = 400, above 380. After: 500 x 0.9 = 450; x 0.75 = 337.5. Shortfall = 380 - 337.5 = USD 42.5 million. Applying only the haircut change (375) gives a shortfall of 5; applying only the price fall (360) gives 20.

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