Skip to content

FRM Part II · FRM Exam Part II · The Failure Mechanics of Dealer Banks

A dealer bank finances USD 50 billion of securities using overnight repo at a 4% haircut. How much of this position must be funded with unsecured funding or equity, and what happens if the haircut rises to 10%?

The dealer must fund USD 2 billion at a 4% haircut, rising to USD 5 billion at 10%, so it needs an extra USD 3 billion. Higher haircuts reduce repo cash received against the same securities, forcing more unsecured or equity funding.

  1. AUSD 2 billion now; USD 5 billion at 10%, so an additional USD 3 billion is neededCorrect
  2. BUSD 4 billion now; USD 10 billion at 10%, so an additional USD 6 billion is needed
  3. CUSD 2 billion now; USD 10 billion at 10%, so an additional USD 8 billion is needed
  4. DUSD 48 billion now; USD 45 billion at 10%, so USD 3 billion is released

Explanation

The haircut portion is 4% x 50 = USD 2 billion; at 10% it is USD 5 billion, requiring an additional USD 3 billion. Option D confuses the cash borrowed with the amount needing other funding.

Did you get it right without looking?

One question tells you little. A timed set on The Failure Mechanics of Dealer Banks shows your real accuracy, how long you take and where you lose marks.

Practise The Failure Mechanics of Dealer BanksFree diagnostic mock

More The Failure Mechanics of Dealer Banks questions