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

A cash lender in a bilateral repo wants to eliminate the risk that the borrower substitutes collateral or that the lender cannot readily reuse the collateral for settlement. A bank is comparing a delivery-versus-payment (DVP) repo with a hold-in-custody (HIC) repo. Which statement is most accurate?

In a DVP repo the collateral is delivered to the lender simultaneously with the cash payment, so the lender controls the securities and settlement and credit risk fall. In a hold-in-custody repo the borrower retains the securities, leaving the lender more exposed, so those alternatives are wrong.

  1. AIn a DVP repo, collateral is delivered to the lender against payment of cash, giving the lender control of the securities and reducing settlement and credit riskCorrect
  2. BIn a HIC repo, the lender receives the securities, so the borrower is exposed to the lender's default only
  3. CIn a DVP repo, the borrower keeps the collateral in its own custody segregated for the lender, creating the highest exposure for the lender
  4. DIn a HIC repo, the lender has full right of rehypothecation as collateral is in its name at a central depository

Explanation

DVP means securities and cash move simultaneously, so the lender holds the collateral and settlement risk is minimized. In HIC, the borrower keeps the securities, so the lender faces more risk if the borrower fails or misuses them. The other statements reverse these features.

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