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FRM Part I · FRM Exam Part I · Anatomy of the Great Financial Crisis of 2007-2009

An investment bank funds $100 billion of assets with $97 billion of overnight repo and $3 billion of equity. Counterparties raise haircuts on its collateral by 2 percentage points, from 3% to 5%, applied to the full asset base. Ignoring other changes, how much additional funding must the bank raise or how many assets must it sell to remain financed?

The bank must raise or free up $2 billion. At a 5% haircut, $100 billion of collateral supports only $95 billion of repo, versus $97 billion before, leaving a $2 billion funding gap that must be covered by new funding or asset sales.

  1. A$2 billionCorrect
  2. B$3 billion
  3. C$5 billion
  4. D$97 billion

Explanation

At a 3% haircut, $100 billion of collateral supports $97 billion of borrowing. At 5%, it supports $95 billion. The shortfall is $97B − $95B = $2 billion, which must be replaced with other funding or asset sales. Using $5 billion confuses the new haircut amount with the change.

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