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FRM Part II · FRM Exam Part II · Liquidity and Leverage

A fund finances USD 200 million of securities with USD 20 million of equity and short-term repo at a 10% haircut. Dealers raise the haircut to 15% while the securities price is unchanged. If the fund keeps its equity at USD 20 million and cannot raise new capital, how much must it sell?

The fund must sell USD 66.7 million. With equity of USD 20 million and a 15% haircut, it can support only 20 divided by 0.15, or USD 133.3 million of assets. Starting from USD 200 million, the required reduction is USD 66.7 million, a margin spiral effect.

  1. AUSD 33.3 million
  2. BUSD 66.7 millionCorrect
  3. CUSD 100 million
  4. DUSD 133.3 million

Explanation

Initial haircut of 10% implies assets of 200 with equity 20 (10%, ignoring other financing details). With a 15% haircut, the maximum assets supportable by 20 of equity are 20/0.15 = 133.3. The fund must sell 200 - 133.3 = 66.7. Selling 33.3 mistakes the remaining equity ratio, and 133.3 is the remaining asset size not the amount sold.

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