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

Which feature of a bilateral repo market most directly makes it susceptible to a run on a dealer bank by its secured lenders?

Repo lenders can decline to roll over short-term transactions and, being secured, can take and sell collateral on default, often exempt from the bankruptcy stay. This gives little incentive to stay with a weakening borrower, so funding can vanish quickly, creating run dynamics.

  1. ALenders can refuse to roll over short-term repos, and collateral can be seized and sold on default, so lenders have little incentive to stayCorrect
  2. BRepo lenders are protected by deposit insurance and so withdraw at once
  3. CRepo borrowers are legally unable to post additional collateral
  4. DRepo contracts have maturities exceeding ten years

Explanation

Repo is mostly very short-term and the lender holds collateral with exemption from the automatic stay in many jurisdictions. Lenders can simply not roll over, withdrawing funding quickly, which resembles a run. Options 1, 2 and 3 are factually incorrect.

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