Financial Risk Manager Part 2
Get started today
Ultimate access to all questions.
A bank is planning to engage in a repurchase agreement (repo) involving a bond it currently holds. Initially, the bank acquires this bond on the day of its coupon payment. Three months thereafter, the bank opts to enter into a repo deal to swiftly raise funds. The following details pertain to the bond and the repo transaction:
- Bond Notional Value: USD 100,000
- Semi-annual Coupon Rate: 5%
- Current Bond Price: USD 98
- Repo Haircut: 5%
- Repo Interest Rate: 3%
- Duration of Repo Contract: 6 months from now
Considering these specific parameters, what will be the bank's projected cash outflow at the conclusion of the repo deal?
Exam-Like
A
USD 94,497
B
USD 95,702
C
USD 97,630
D
USD 100,739
Explanation:
The correct answer is B: USD 95,702. Here's the explanation:
- The bank buys a bond with a notional amount of USD 100,000 on its coupon payment date.
- The semi-annual coupon rate is 5%, and the current bond price is USD 98 (which is 98% of the face value).
- The bank decides to repo the bond to generate immediate liquidity after three months.
- The repo haircut is 5%, and the repo interest rate is 3%.
- The repo contract expires 6 months from now.
To calculate the bank's expected cash outflow at the end of the repo transaction, we follow these steps:
-
Calculate the cash inflow at the beginning of the repo:
- The bank receives 98% of the notional amount (due to the bond price) plus 5% of the notional amount for the accrued interest for the first quarter (0.25 years).
- Apply the repo haircut of 5% to the total amount.
- Cash inflow = (100,000 * (98% + 5% * 0.25) * (1 - 5%)) = USD 94,288.
-
Calculate the cash outflow at the end of the repo:
- The bank needs to return the repo amount plus the repo interest for the 3-month period.
- Repo interest = 3% * 0.5 (as the repo contract expires in 6 months, and the interest is for half a year).
- Cash outflow = 94,288 * (1 + 3% * 0.5) = USD 95,702.
So, the bank's expected cash outflow at the end of the repo transaction is USD 95,702.
Comments
Loading comments...