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FRM Part II · FRM Exam Part II · The Failure Mechanics of Dealer Banks

In Duffie's analysis of the failure mechanics of dealer banks, which feature of tri-party repo financing most directly explains why a dealer's secured funding can disappear quickly when counterparties lose confidence?

Because most repo is overnight, lenders can refuse to roll it or demand larger haircuts, and the dealer must replace the funding almost immediately. This short maturity makes secured funding highly runnable despite the collateral backing it.

  1. ARepo lenders usually hold unsecured claims on the dealer's parent company only
  2. BMost repo is overnight, so lenders can decline to roll it and the dealer must replace the funding almost immediatelyCorrect
  3. CRepo collateral is always cash, which cannot be liquidated by lenders
  4. DRepo funding is locked in for terms of more than one year, forcing asset sales at maturity

Explanation

Much dealer repo is overnight and must be rolled daily. If lenders lose confidence they simply do not roll, or they raise haircuts, and funding vanishes in a day. The other options misdescribe repo: it is collateralized and short-term, not long-term.

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