When Repo Collateral Creates FX Exposure and Default Risk

# Can repos be exposed to FX Delta risk?


# Can repos be exposed to FX Delta risk?












I am a beginner to Repos. In the place I work there are multiple risks (FX delta, IR delta, etc.) listed under Repos. However, one of my colleagues told me to ignore "FX delta" risk for Repos.

Is his statement right? Is it possible that the colateral of the repo is a product that bares FX delta risk? Any explanation would be appreciated

## Answer by AlRacoon (score 1)

https://quant.stackexchange.com/a/58027

I am not sure exactly why your colleague suggested you ignore the FX delta risk for the repo but as @kurtosis suggested, perhaps the loan (ultimately repo is collateralized lending) is in the same currency as the collateral. Or perhaps there is an FX forward that your firm has on to hedge the FX risk for the term of the repo.

Technically, there is nothing to prohibit the possibility of FX risk to be in a repo trade. For example, if you are the lender and buy the collateral from the borrower, and the collateral is denominated in a different currency than your functional currency (ie sovereign local currency bonds), you will be exposed to FX risk. You will be required to sell the collateral back to the borrower at the contracted local currency price and will then be required to convert the local currency proceeds back to your functional currency.

If your firm has local currency needs and maintains a balance of local currency to serve cash flow needs in that local currency, they may be unconcerned about the FX risk. Alternatively, there may be an offsetting hedge through a FX forward that has locked in the rate at which they will be converting the proceeds from the collateral sale back to your firm's functional currency--thereby eliminating any FX risk.

## Answer by ZRH (score 0)

https://quant.stackexchange.com/a/58029

I think there are two aspects here:

- Valuation of the loan element: The valuation on a repo deal is ONLY done with the repo rate of the currency of the cash that has been extended. For a spot starting repo, that's just the MTM valuation of the final cashflow. Given the size of the cash flow is fixed and does not depend on the value of the collateral, the repo has no dependence on any of the deltas of the underlying paper. Given repos are collateralized, the deviation of the repo rate from the risk free rate in the same currency should NOT depend on how risky the paper is, but only on supply/demand for lending/borrowing against that paper.

- Risk of the collateral element: The credit risk on the repo depends on how volatile the value of the collateral is. On a day-to-day basis, this is mitigated by margin calls and a haircut that needs to be kept. If in the event of repo counterparty default, liquidation occurs, there is a risk of not getting enough cash to cover the claim, and that, for a x-currency repo also depends on FX volatility. Cash revenues upon liquidation are in a different currency from that of the claim.

In summary, the valuation of the repo should not have any FX dependence, i.e. the repo has no FX delta, but credit risk on the repo does depend on FX volatility