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FRM Part II · FRM Exam Part II · Managing Nondeposit Liabilities

A money market fund lends cash against Treasury collateral in a tri-party repo. Which feature most directly reduces the fund's credit exposure to the borrowing dealer if the dealer defaults?

Overcollateralization through a haircut, maintained by daily margining, most directly reduces the lender's exposure. If the dealer defaults, the lender can sell collateral worth more than the cash advanced. Higher rates, longer terms or the dealer's own paper do not protect against loss.

  1. AReceiving collateral with market value above the cash lent, through a haircut, with daily marginingCorrect
  2. BLending at a higher repo rate than the general collateral rate
  3. CExtending the term of the repo from overnight to one month
  4. DAccepting the dealer's own unsecured notes as collateral

Explanation

A haircut and daily mark-to-market with margin calls keep collateral value above the cash lent, so the lender can liquidate collateral to recover the loan. A higher rate only compensates risk. A longer term increases the exposure window and the collateral price risk. Own-issued notes create wrong-way risk.

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