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

A dealer bank lends cash to a hedge fund and receives government bonds as collateral under a repurchase agreement. From the dealer's perspective, which description of this transaction is correct?

The dealer is conducting a reverse repo. It lends cash and receives bonds as collateral, then resells the same bonds back at maturity for the cash plus interest. The counterparty, the hedge fund, is the one doing the repo by selling and repurchasing the securities.

  1. AA reverse repo, because the dealer buys the securities now and agrees to sell them back laterCorrect
  2. BA repo, because the dealer sells the securities now and agrees to buy them back later
  3. CA securities lending trade with no cash leg, because collateral is exchanged
  4. DAn outright purchase of the bonds, because title passes permanently to the dealer

Explanation

The dealer provides cash and takes securities, then returns the securities for cash plus interest at maturity. That is a reverse repo from the dealer's side. The hedge fund is the party doing the repo. Calling it a repo confuses the two sides of the same trade.

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