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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 worth 102 million (market value) for 100 million in cash and agrees to buy them back the next day at a price that includes interest. From the dealer's perspective as the cash borrower, what is the haircut on this transaction?

The haircut is about 1.96%. It is measured as the excess of collateral value over cash lent, divided by the collateral market value: (102 − 100)/102. Dividing by the cash amount instead gives 2%, which is the initial margin ratio, not the haircut.

  1. AAbout 1.96%, because the haircut is 2 divided by 102Correct
  2. B2.00%, because the haircut is 2 divided by 100
  3. C0.00%, because the repo is fully collateralised
  4. D102.00%, because the haircut equals collateral over cash

Explanation

Haircut = (collateral value − cash lent) / collateral value = (102 − 100)/102 = 1.96%. Using cash as the denominator gives 2.00%, which is the overcollateralisation (margin) ratio, not the haircut.

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