FRM Part II · FRM Exam Part II · Liquidity and Leverage
A hedge fund buys a bond for 100 using a repo with a 5% haircut. How much of its own capital must the fund post to hold the position?
The fund must post 5 of its own capital. A 5% haircut means the repo lender advances only 95 against a bond worth 100, so the borrower funds the difference of 5 itself, which is the equity in the position.
- A5, because the haircut is the equity the borrower must fundCorrect
- B95, because the lender advances only the equity
- C100, because the repo provides no financing
- D10, because haircuts are always doubled for hedge funds
Explanation
With a 5% haircut the lender advances 95 against collateral worth 100. The borrower funds the remaining 5 from its own capital. The 95 option confuses the loan amount with the equity.
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