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

A dealer enters a repurchase agreement in which it sells securities today and agrees to buy them back tomorrow at a slightly higher price. From the dealer's perspective, which description is correct?

The dealer is conducting a secured borrowing. It receives cash against securities and repurchases them at a higher price, and the difference is interest at the repo rate. The counterparty is the one lending cash, which is a reverse repo.

  1. AIt is a secured borrowing, and the price difference represents interest on the cash receivedCorrect
  2. BIt is an unsecured borrowing, and the price difference is a trading gain
  3. CIt is a secured lending of cash, and the dealer receives interest
  4. DIt is an outright sale, and the dealer has no obligation to repurchase

Explanation

The seller of securities in a repo receives cash and pledges securities, so it is borrowing on a secured basis. The higher repurchase price over the sale price is the interest cost (repo rate). Describing it as lending reverses the roles, which is the reverse repo side.

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