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

A dealer bank with USD 100 billion of assets holds USD 6 billion of equity. A run causes repo lenders to apply new haircuts: on USD 60 billion of repo-funded assets the haircut rises from 5% to 10%. Assuming no other change, how much additional funding must the dealer find immediately, and how does it compare to equity?

The dealer must find USD 3 billion, which is half of its USD 6 billion equity. A five-point rise in the haircut on USD 60 billion of repo-funded assets cuts the cash lent by USD 3 billion, which the dealer must replace with other funding.

  1. AUSD 3 billion, half of equityCorrect
  2. BUSD 6 billion, equal to equity
  3. CUSD 9 billion, 1.5 times equity
  4. DUSD 30 billion, five times equity

Explanation

Haircut increase is 5 percentage points on USD 60 billion = USD 3 billion of extra own funding needed (cash lent falls from 57 to 54 billion). That is 3/6 = 50% of equity. USD 6 billion would result from a 10-point rise; applying 10% on the full amount mistakenly gives a larger figure.

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