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

A dealer repos USD 50 million market value of corporate bonds with a 8% haircut. Under stress, the lender raises the haircut to 12% on the same collateral, whose market value is unchanged. By how much does the cash the dealer can raise fall, and which concept does this illustrate?

At an 8% haircut the dealer raises USD 46.0 million, and at 12% only USD 44.0 million, so cash falls by USD 2.0 million. This is a funding liquidity shock from a haircut increase, which the dealer must cover from other sources.

  1. AUSD 2.0 million; the dealer faces a margin spiral from a higher haircut
  2. BUSD 4.0 million; the dealer must replace the lost cash from other sources, which is a funding liquidity shock via a haircut increaseCorrect
  3. CUSD 6.0 million; the dealer faces a pure mark-to-market loss on the bonds
  4. DUSD 4.0 million; the bonds have lost value because the repo rate rose

Explanation

Cash at 8% haircut = 50 x 0.92 = 46.0 million. Cash at 12% haircut = 50 x 0.88 = 44.0 million. The fall is 2.0 million. Rechecking: haircut change of 4% of 50 = 2.0 million, so the option stating 4.0 million is wrong.

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