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

During a stress period, a securities dealer funded by overnight repo finds that cash lenders raise haircuts on its lower-quality collateral while leaving rates unchanged. Which description of the consequence is most accurate?

The dealer must find more funding elsewhere. A higher haircut reduces the cash received against the same collateral, so a bigger part of inventory must be financed by unsecured borrowing or equity. This increases liquidity pressure, even if the stated repo rate is unchanged.

  1. AThe dealer's funding need falls because lenders advance less cash against the same securities
  2. BThe dealer must fund a larger share of its inventory with unsecured sources or equity, increasing liquidity strainCorrect
  3. CThe dealer's repo interest cost rises mechanically in proportion to the haircut increase
  4. DThe dealer's collateral is automatically moved to the central bank

Explanation

A higher haircut means less cash per unit of collateral, so the dealer must replace the shortfall with other funding. Its need does not fall; the gap widens. Rates are unchanged, and nothing moves collateral to the central bank automatically.

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