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

A dealer bank enters a repo in which it sells securities with a market value of USD 102 million for USD 100 million cash and agrees to repurchase them the next day. Which statement best describes the haircut on this transaction?

The haircut is about 1.96%. It is measured as the excess of collateral value over cash lent, USD 2 million, divided by the collateral market value of USD 102 million. Dividing by the cash lent would give 2%, which is the wrong base.

  1. AThe haircut is about 1.96%, being the cash shortfall as a percentage of the securities' market valueCorrect
  2. BThe haircut is 2.00%, being the cash shortfall as a percentage of the cash lent
  3. CThe haircut is 102%, being the ratio of collateral value to cash
  4. DThe haircut is zero because the securities are repurchased at maturity

Explanation

Haircut = (collateral value - cash)/collateral value = (102 - 100)/102 = 1.96%. Option B uses the cash lent as the base, which is the wrong denominator (it is the overcollateralisation, not the haircut). Option C is the collateral-to-cash ratio, not a haircut.

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