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

A treasurer wants to reduce the risk that a counterparty's sudden margin or haircut increase creates a funding shortfall on repo-financed positions. Which action most directly addresses this risk?

Using term repo with haircuts fixed for the tenor, and spreading financing across several lenders, most directly protects against sudden margin increases. Overnight funding lets lenders reprice immediately, while concentration with one dealer raises dependence, so both increase the shortfall risk.

  1. ARolling all repo financing overnight to maximize flexibility
  2. BUsing term repo with fixed haircuts and diversifying across lendersCorrect
  3. CConcentrating financing with a single dealer to negotiate lower haircuts
  4. DHolding collateral only in the most volatile liquid securities

Explanation

Term funding with haircuts locked for the tenor prevents lenders from repricing in stress, and diversification reduces dependence on one counterparty. Overnight rolling exposes the firm to immediate haircut changes, and concentration increases counterparty dependence.

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