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FRM Part II · FRM Exam Part II · Repurchase Agreements and Financing

Compared with bilateral repo, which statement best describes a risk associated with tri-party repo during a dealer's distress?

The clearing bank's intraday credit during the morning unwind is a key vulnerability. If it is withdrawn from a distressed dealer, financing fails quickly, accelerating a run. Tri-party arrangements do not remove rollover risk or guarantee lender repayment.

  1. AIntraday credit extended by the clearing bank to unwind trades each morning can be withdrawn, accelerating a runCorrect
  2. BTri-party repo eliminates all rollover risk because collateral is allocated automatically
  3. CCash lenders bear no counterparty risk because the clearing bank guarantees repayment
  4. DTri-party repo cannot be used with securities other than government bonds

Explanation

In the tri-party unwind, the clearing bank returns cash to lenders each morning and extends intraday credit to the dealer. If the clearing bank becomes unwilling to do so for a distressed dealer, the funding collapses quickly. Automatic collateral allocation does not remove rollover risk and the clearing bank does not guarantee repayment.

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