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

A dealer finances a bond position through tri-party repo and bilateral repo. A risk manager is assessing how a repo lender's rights differ if the dealer defaults. Which statement best describes the lender's position in a standard repo under typical documentation?

In a standard repo the lender holds title to the collateral and can usually sell it promptly on default, applying proceeds to its claim and returning any surplus to the borrower. This quick close-out right, rather than waiting for court approval, is what makes repo lending low risk.

  1. AThe lender must wait for bankruptcy court approval before selling the collateral, because it only holds a security interest
  2. BThe lender holds title to the collateral and can typically sell it immediately on default, keeping proceeds up to its claim and returning any surplusCorrect
  3. CThe lender is an unsecured creditor for any amount above the haircut, with no right to sell the collateral
  4. DThe lender must return the collateral and file a claim, because repos are treated as loans in all circumstances

Explanation

In a repo the cash lender receives title to the securities, and standard documentation gives close-out and netting rights, often with safe-harbor treatment from the automatic stay. The lender can sell the collateral, apply proceeds to its claim and return any excess. The security-interest-only and unsecured descriptions understate the lender's rights.

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