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

A dealer bank's repo lenders raise haircuts on its collateral from 5% to 10% on USD 200 billion of overnight-financed securities, with no change in asset values. Ignoring other changes, how much additional funding must the dealer replace?

Repo cash falls from 95% to 90% of USD 200 billion, i.e. from 190 to 180 billion, so the dealer must replace USD 10 billion. The 20 billion answer wrongly uses the whole new haircut rather than the increase.

  1. AUSD 5 billion
  2. BUSD 10 billionCorrect
  3. CUSD 20 billion
  4. DUSD 100 billion

Explanation

Cash raised at 5% haircut = 200 x 0.95 = 190. At 10% = 200 x 0.90 = 180. The shortfall is USD 10 billion. Choosing 5 billion takes the haircut change as a share of the wrong figure, and 20 billion uses the full new haircut.

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