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

A dealer finances $50 billion of securities in repo with a 4% haircut. Lenders raise the haircut to 10% across the board. Assuming the securities are unchanged in value and the dealer must keep the full position, how much additional own funding does the dealer need?

The dealer needs an additional $3 billion. Borrowing capacity falls from $48 billion (96% of $50 billion) to $45 billion (90%) when the haircut rises from 4% to 10%, so the 6 percentage point increase on $50 billion must be funded elsewhere.

  1. A$1.0 billion
  2. B$2.0 billion
  3. C$3.0 billionCorrect
  4. D$5.0 billion

Explanation

Cash borrowed at 4% haircut = 50 x 0.96 = $48 billion. At 10% haircut = 50 x 0.90 = $45 billion. The difference is $3 billion needed from other sources. The $2 billion option applies only the 4% haircut; $5 billion uses the new haircut alone as extra, ignoring the existing 4%; $1 billion is a wrong base.

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