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FRM Part I · FRM Exam Part I · Learning From Financial Disasters

A hedge fund has USD 5 billion of assets financed by USD 4.75 billion of repo borrowing and USD 250 million of equity. Lenders raise the haircut so that they will lend only 90% of asset value, and the assets' market value falls 2% at the same time. Assuming the fund must fully repay any shortfall in cash, how much additional cash must it raise to maintain its borrowing within the new limit?

The fund must raise USD 340 million. After a 2% fall, assets are worth USD 4,900 million, and a 90% advance rate allows borrowing of only USD 4,410 million. Existing repo debt is USD 4,750 million, so the USD 340 million shortfall must be repaid in cash.

  1. AUSD 340 millionCorrect
  2. BUSD 250 million
  3. CUSD 500 million
  4. DUSD 90 million

Explanation

New asset value = 5,000 x 0.98 = USD 4,900 million. Maximum borrowing = 0.90 x 4,900 = USD 4,410 million. Existing borrowing is USD 4,750 million, so the shortfall is 4,750 - 4,410 = USD 340 million. USD 500 million is the haircut effect alone on the original value (5,000 x 0.10), which ignores the borrowing and price move.

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