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

A broker-dealer holds assets of USD 100 million financed with USD 95 million of short-term repo borrowing and USD 5 million of equity. Asset prices fall 3%, and the dealer wants to restore its original leverage ratio (assets/equity) by selling assets and repaying debt, leaving equity unchanged after the loss. What is the value of assets it must sell at the new prices?

The dealer must sell USD 57 million. After the 3% fall, assets are USD 97 million and equity is USD 2 million. Restoring leverage of 20 requires assets of USD 40 million, so it must sell 97 minus 40, which is USD 57 million.

  1. AUSD 38 million
  2. BUSD 42 million
  3. CUSD 51 million
  4. DUSD 57 millionCorrect

Explanation

Original leverage is 100/5 = 20. After a 3% fall, assets are 97 and equity is 2. To restore leverage of 20 with equity of 2, assets must be 40. The dealer must sell 97 - 40 = 57 million. Selling 38 or 42 results from miscomputing the target, and 51 comes from ignoring the loss to equity.

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