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

A dealer bank finances a government bond position by lending the bond to a cash investor and receiving cash, with an agreement to buy the bond back at a higher price on a set future date. From the dealer's perspective, which description of this transaction is correct?

The dealer is doing a repo: it sells the bond for cash and agrees to repurchase it later at a higher price. The cash investor is on the reverse repo side. Ownership is temporary and cash is exchanged, so it is neither an outright sale nor securities lending.

  1. AA reverse repo, because the dealer receives collateral and lends cash
  2. BA repo, because the dealer sells the security and agrees to repurchase itCorrect
  3. CAn outright sale, because title to the bond passes permanently
  4. DA securities lending trade, because no cash changes hands

Explanation

A repo is the sale of a security with an agreement to repurchase it later at a higher price; the dealer raises cash, so it is the repo side. The reverse repo is the cash lender's side. The trade is not permanent, and cash does change hands.

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