Skip to content

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

Which policy tool would most directly reduce the risk of a fire sale following a run on a dealer's tri-party repo funding?

Setting minimum, countercyclical haircuts that do not spike in stress best reduces fire-sale risk. It limits sudden increases in the cash a dealer must supply itself, so it is less forced to dump assets. Shorter maturities and unlimited rehypothecation would increase run vulnerability.

  1. AAllowing intraday credit from clearing banks to be unwound at the start of each day regardless of dealer condition
  2. BSetting minimum, countercyclical haircuts that do not rise sharply in stressCorrect
  3. CShortening the maturity of repo contracts to overnight
  4. DPermitting unlimited rehypothecation of client assets

Explanation

Stable, minimum haircuts limit procyclical jumps in the funding the dealer must supply, reducing forced asset sales. Shorter maturities raise rollover risk, and unlimited rehypothecation increases interconnected funding dependence.

Did you get it right without looking?

One question tells you little. A timed set on The Failure Mechanics of Dealer Banks shows your real accuracy, how long you take and where you lose marks.

Practise The Failure Mechanics of Dealer BanksFree diagnostic mock

More The Failure Mechanics of Dealer Banks questions