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Answer: A repo rate is essentially similar to the federal funds rate except that a repo rate can only be an overnight (i.e., one day) rate and will be slightly higher due to its additional credit risk
### Correct answer: A Statement **A** is false. - A **repo rate** is a rate on a repurchase agreement, which is a **secured** borrowing/lending transaction. It is not limited to being only overnight; repos can also have longer maturities. - Also, because repo is **secured by collateral**, its rate is generally **lower** than an unsecured rate such as the federal funds rate, not higher. Statements **B**, **C**, and **D** are consistent with standard interest-rate definitions: - **Treasury rates** are often treated as near risk-free, but not always the preferred discount rate for derivatives. - **OIS rates** became the preferred proxy for risk-free discounting after the GFC. - **LIBOR** is an unsecured interbank borrowing rate based on bank submissions rather than actual transaction prices, which is one reason it was replaced as a benchmark.
Author: Manit Arora
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Question 712.1: Interest rates are a fundamental and essential building block in finance. As Hull reminds us, "for any given currency, many different types of interest rates are regularly quoted. These include mortgage rates, deposit rates, prime borrowing rates, and so on" and, further, interest rates are a factor in the valuation of virtually all derivatives. Consequently, fluency in finance requires that we achieve proficiency with the different types of rates and an ability to manipulate them depending on the circumstance. Each of the following statements is true EXCEPT which is false?
A
A repo rate is essentially similar to the federal funds rate except that a repo rate can only be an overnight (i.e., one day) rate and will be slightly higher due to its additional credit risk
B
Treasury rates are (i) the rates earned on instruments issued by a government to borrows in its own currency, (ii) are generally regarded as risk-free, but (iii) tend NOT to be the risk-free rate used to value derivatives
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