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

A cash lender has a reverse repo with a dealer. The collateral's market value falls below the required level after a sharp rise in yields. Under standard margining mechanics, what is the most appropriate action?

The lender should make a margin call. Because the collateral has lost value, the lender is under-collateralized, so the dealer must deliver additional securities or cash to restore the required coverage.

  1. AThe lender issues a margin call, requiring the dealer to deliver additional collateral or cashCorrect
  2. BThe lender must return some cash to the dealer
  3. CThe repo rate is automatically reduced to compensate
  4. DThe haircut is waived until maturity

Explanation

When collateral value falls, the lender is under-secured and calls margin from the borrower of cash, who must post additional securities or cash. Returning cash would worsen the lender's exposure.

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