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

During the 2007-2009 crisis, repo haircuts on structured credit rose sharply. Which interpretation best fits the concept of a 'run on repo'?

A run on repo occurs when lenders raise haircuts or refuse to roll funding, which forces borrowers to sell assets. The sales depress prices and increase perceived risk, prompting yet higher haircuts, so the process feeds on itself and amplifies funding stress.

  1. AA rise in haircuts or refusal to roll acts like a withdrawal of funding, forcing asset sales that depress prices and raise haircuts furtherCorrect
  2. BA fall in haircuts that encourages additional borrowing
  3. CA central bank decision to raise the policy rate by a small amount
  4. DA shift of lenders from secured to unsecured lending, which stabilizes funding

Explanation

Run dynamics involve a self-reinforcing loop: higher haircuts force deleveraging, asset sales lower prices, and lower prices and higher volatility lead lenders to demand still higher haircuts. The other options describe benign or unrelated events.

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