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

A dealer sells USD 50 million of Treasury bonds to a money market fund and agrees to repurchase them the next day at a slightly higher price. From the dealer's perspective, which description of this transaction is correct?

The dealer is doing a repo: it sells the bonds for cash today and agrees to buy them back later at a higher price. Economically it is a collateralized cash borrowing, while the money market fund is lending cash and doing a reverse repo.

  1. AA repo, in which the dealer borrows cash and provides the bonds as collateralCorrect
  2. BA reverse repo, in which the dealer lends cash and receives the bonds as collateral
  3. CAn outright sale with no obligation to repurchase the bonds
  4. DAn unsecured deposit taken from the money market fund

Explanation

In a repo the seller of the security receives cash and commits to repurchase it later at a higher price, the difference being the repo interest. The dealer is therefore borrowing cash against collateral. The money market fund is the party doing the reverse repo.

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