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

A dealer enters a 30-day repo in which it sells USD 50 million of Treasury notes (market value) to a money market fund and agrees to repurchase them at a higher price. From the dealer's perspective, which description of the transaction is correct?

The dealer is doing a repo. It sells securities for cash and commits to buy them back later at a higher price, which is effectively a collateralized loan. The money market fund, which provides cash and receives securities, is the party doing the reverse repo.

  1. AIt is a reverse repo, because the dealer lends securities and receives cash
  2. BIt is a repo, because the dealer sells securities for cash and agrees to buy them back laterCorrect
  3. CIt is a reverse repo, because the dealer receives securities and provides cash
  4. DIt is an outright sale, because title to the securities passes permanently

Explanation

A repo is a sale of securities with an agreement to repurchase at a later date at a higher price, which is economically a collateralized cash borrowing. The dealer is the cash borrower, so it is doing a repo. The money market fund is doing the reverse repo. The outright sale option is wrong because the repurchase commitment makes it a financing.

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