Economics
Repurchase Agreement
A repurchase agreement, or repo, is a short-term borrowing arrangement where one party sells securities to another with an agreement to repurchase them at a later date, usually within a few days. The seller pays interest to the buyer for the use of the funds. Repos are commonly used in financial markets for liquidity management and short-term funding.
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9 Key excerpts on "Repurchase Agreement"
eBook - ePubThe Capital Markets
Evolution of the Financial Ecosystem
- Gary Strumeyer(Author)
- 2017(Publication Date)
- Wiley(Publisher)
CHAPTER 9 Repurchase Agreements Karl Schultz and Jeffrey Bockian INTRODUCTION A Repurchase Agreement is a financing transaction executed when a holder of securities sells them to an investor and simultaneously agrees to repurchase them at the same dollar price on a specified future date. The difference between the sale price and the subsequent repurchase price represents interest over the period. In effect the seller of the securities is borrowing funds from the buyer and repaying the loan when the securities are repurchased. The term repo is used to describe the transaction from the perspective of the borrower or seller of the securities. The lender of the funds or purchaser of the securities initially is engaging in a reverse Repurchase Agreement (reverse repo). Repo transactions can alternatively be viewed as the economic equivalent of secured loans, where the seller of the securities is in effect borrowing funds from the buyer and pledging the securities as collateral. However, despite some economic similarities, Repurchase Agreements differ from secured loans as repos feature title transfer of collateral from the seller to the buyer. In contrast, a secured loan typically operates under a pledge structure in which the borrower retains ownership of the securities upon which the lender retains a lien. Another key difference between repos and secured loans is that repos are generally exempt from stay under the bankruptcy code
eBook - ePub- Vicente Galbis(Author)
- 1991(Publication Date)
- INTERNATIONAL MONETARY FUND(Publisher)
Section IV .
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I. The Repo Market
A Repurchase Agreement is an acquisition of immediately available funds through the sale of securities with the simultaneous commitment by the seller or borrower to repurchase them at a later date.2 The same transaction from the perspective of the supplier of funds is called a reverse Repurchase Agreement (reverse repo). Whereas a repo combines a spot sale with a forward purchase, a reverse repo involves a spot purchase and forward sale.3The Repo Contract
The repo contract establishes the underlying security or securities, the interest rate, the repurchase price, and the term and maturity of the arrangement. Normally it does not cover default arrangements involving bankruptcy of one of the parties.In principle, any asset can be used as the underlying security in the repo transaction, but in practice U.S. government and federal agencies’ securities are more widely used because of their liquidity, low risk, and active market. Other assets that can be used are money market instruments such as certificates of deposit, banker’s acceptances, commercial paper, and commercial banks’ loans or mortgage-backed securities. The use of a mix of different securities in a repo transaction is also common. For illustrative purposes, the following discussion will be limited to transactions involving government securities. However, the same principles apply to repos involving all classes of securities.The role of the underlying security is only to provide collateral to the buyer or lender, not to determine the interest rate on the agreement, which is determined by the money market. The repo rate is typically lower than the rate on federal funds loans, which are not collateralized.4The repurchase price in the repo transaction can be set either at or above the same level as the sale price. If set at the same level, the parties will arrange for a separate interest payment for the use of the acquired funds; if set above the sale price, the difference reflects the implicit interest rate on the contract. Usually a margin, or “haircut,” is set to protect the lender or buyer against fluctuations in the market value of the underlying securities.5 The amount of funds transferred (sale price) is thus equal to the market value of the underlying security plus (in the case of coupon securities) accrued interest less the margin.6 In general, the margin will be larger the longer is the maturity of the underlying security and the less liquid the security is. Haircuts range from 1 percent to 5 percent, but may be as low as 1/8 percent of a point for very short-term securities.7
eBook - PDFFixed Income Securities
Tools for Today's Markets
- Bruce Tuckman, Angel Serrat(Authors)
- 2022(Publication Date)
- Wiley(Publisher)
10.1 Repurchase AgreementS The most straightforward description of a Repurchase Agreement or repo is as a secured loan with bonds or other financial instruments as collateral. Figures 10.1 and 10.2 depict an example in which one counterparty – the “repo seller” – borrows $109,898,438 for 44 days at a rate of 0.015%, while giving $100 million of the 2.75s of 02/15/2028 as collateral. At the time of the trade, the price of the bond is 109-28 3/4, that is, 109 + 28.75∕32 = 109.898438 per 100 face amount, which means that the value of the col- lateral at the start of the trade equals the amount loaned. In practice, the 223 224 FIXED INCOME SECURITIES Repo Seller Repo Buyer / Investor $100mm face 2.75s of 2/15/2028 $109,898,438 FIGURE 10.1 Initiation of a Repurchase Agreement. $100mm face 2.75s of 2/15/2028 $109,900,452 Repo Seller Repo Buyer / Investor FIGURE 10.2 Unwind of a Repurchase Agreement. value of the collateral typically exceeds the amount loaned, and this feature of repo is discussed next. Continuing with the present example, however, Figure 10.1 shows the flows of cash and bonds at the initiation of the trade, and Figure 10.2 shows the flows at the expiration or unwind of the trade. In the latter, the repo seller pays principal plus interest, $109,898, 438 × (1 + 0.015% × 44∕360), or $109,900,452, to discharge the loan, and then takes back its $100 million face amount of bonds. The lender of cash in Figures 10.1 and 10.2 is protected by the bonds taken as collateral against the loans: if the borrower of cash defaults, the lender of cash has a claim on those bonds. But lenders of cash in the repo market are protected even further by a safe harbor from the bankruptcy code, by a haircut or initial margin, and by variation margin. With respect to the safe harbor, if the borrower of cash defaults on its loan, the lender may immediately liquidate the bonds held as collateral to recover the loan amount, returning any realized excess cash to the borrower.
eBook - ePubThe Business of Investment Banking
A Comprehensive Overview
- K. Thomas Liaw(Author)
- 2011(Publication Date)
- Wiley(Publisher)
CHAPTER 13 Repurchase AgreementS AND PRIME BROKERAGE Repurchase Agreements (repos) are extensively used in dealer funding, customer financing, and matched-book trading. The repo desk has become the hub around which the trading, hedging, and arbitrage strategies revolve. At many firms the repo desk has become a key profit center. Understanding the repo market is essential to assessing value in the fixed-income markets. For example, the status of a bond in the repo market can be used to understand the relative values between bonds and also to assess the valuation of futures contracts. This chapter describes the structure, development, trading mechanics, and market practices for repos. Later sections of the chapter cover the upper and lower bounds of special repo rates, brokering, and matched-book transactions. Investment banks provide prime brokerage services as well. FIXED-INCOME Repurchase AgreementS The fixed-income repo market is the biggest money market. This is much larger than the federal funds market and is the biggest short-term money market in the world. Government securities dealers borrow huge amounts of short-term funds to finance their positions every day, and often they find that the least expensive way to do so is in the Repurchase Agreement (repo) market. In a typical repo transaction, a dealer puts up liquid securities as collateral against a cash loan while agreeing to repurchase the same securities at a future date at a higher price that reflects the financing costs. A typical transaction is depicted in Figure 13.1. The sale is the start leg, and the repurchase is the close leg. The party that lends securities in exchange for cash is often referred to as the collateral seller. The counterparty that takes in securities and lends out funds is called the collateral buyer. In practice, a repo is generally described from the dealer's perspective
eBook - PDF- (Author)
- 2022(Publication Date)
- Wiley(Publisher)
Repurchase Agreements are a common source of money market funding for dealer firms in many countries. An active market in Repurchase Agreements underpins every liquid bond market. Financial and non-financial companies participate actively in the market as both sellers and buyers of collateral depending on their circumstances. Central banks are also active users of Repurchase Agreements in their daily open market operations; they either lend to the market to increase the supply of funds or withdraw surplus funds from the market. 11.1. Structure of Repurchase and Reverse Repurchase Agreements Suppose a government securities dealer purchases a 2.25% UK gilt that matures in three years. The dealer wants to fund the position overnight through the end of the next business day. The dealer could finance the transaction with its own funds, which is what other market partici- pants, such as insurance companies or pension funds, may do in similar circumstances. But a securities dealer typically uses leverage (debt) to fund the position. Rather than borrowing from a bank, the dealer uses a Repurchase Agreement to obtain financing by using the gilt as collateral for the loan. A Repurchase Agreement may be constructed as follows: The dealer sells the 2.25% UK gilt that matures in three years to a counterparty for cash today. At the same time, the dealer makes a promise to buy the same gilt the next business day for an agreed-on price. The price at which the dealer repurchases the gilt is known as the repurchase price. The date when the gilt is repurchased, the next business day in this example, is called the repurchase date. When the term of a Repurchase Agreement is one day, it is called an “overnight repo.” When the agreement is for more than one day, it is called a “term repo.” An agreement lasting until the final maturity date is known as a “repo to maturity.”
eBook - PDFSecurities Finance
Securities Lending and Repurchase Agreements
- Frank J. Fabozzi, Steven V. Mann(Authors)
- 2005(Publication Date)
- Wiley(Publisher)
As before, whether the transaction is a repo or reverse is viewed from the dealer’s perspective. This type of transaction is driven primarily for accounting/tax reasons. For example, suppose a dealer has a customer has bond in their portfolio that they would like to sell but the bond is trading below its carrying value. Furthermore, sup- pose the customer does have any gains to offset the loss. In this case, the customer might consider a repo to maturity as an alternative to selling the Year Reverse Repurchase Repurchase Total 1981 46.7 65.4 112.1 1982 75.1 95.2 170.3 1983 81.7 102.4 184.1 1984 112.4 132.6 245.0 1985 147.9 172.9 320.8 1986 207.7 244.5 452.2 1987 275.0 292.0 567.0 1988 313.6 309.7 623.3 1989 383.2 398.2 781.4 1990 377.1 413.5 790.5 1991 417.0 496.6 913.6 1992 511.1 628.2 1,139.3 1993 594.1 765.6 1,359.7 1994 651.2 825.9 1,477.1 1995 618.8 821.5 1,440.3 1996 718.1 973.7 1,691.8 1997 883.0 1,159.0 2,042.0 1998 1,111.4 1,414.0 2,525.5 1999 1,070.1 1,361.0 2,431.1 2000 1,093.3 1,439.6 2,532.9 2001 1,311.3 1,786,5 3,097.7 2002 1,615.7 2,172.4 3,788.1 Repurchase and Reverse Repurchase Agreements 237 bond. By doing so, the customer is using the bonds as collateral for a loan and gains access to funds without selling the bond outright. BUY/SELL BACK Another securities lending arrangement that is functionally equivalent to a Repurchase Agreement is a buy/sell back agreement. A buy/sell back agree- ment separates a securities lending transaction into separate buy and sell trades that are entered into simultaneously. The security borrower buys the security in question and agrees to return the borrowed security (i.e., sell back) at some future date for an agreed upon forward price. The for- ward price is usually derived using a repo rate. A buy/sell back agreement differs from a Repurchase Agreement in that the security borrower receives legal title and beneficial ownership of the securities for the length of the agreement.
eBook - ePubInside the Currency Market
Mechanics, Valuation and Strategies
- Brian Twomey(Author)
- 2011(Publication Date)
- Bloomberg Press(Publisher)
CHAPTER 4 Short-Term Interest Rates and Money Market InstrumentsThe purpose of this chapter is not necessarily to know how to trade Repurchase Agreements although a full outline is presented. Instead, Repurchase Agreements represent the shortest-term interest rate within a nation, the prime mover of a spot price. These shortest-term interest rates can connect to a currency price through factors of interest. Factors of interest for Repurchase Agreements represent the shortest-term deposit rates and deposit rates represent the bid side of a currency pair. It determines the cost of money. A bid side rate represents the floor for rates, so it is imperative to understand this market.Repurchase AgreementsRepurchase Agreements comprise two forms, a repo rate and a reverse-repo rate. The reverse-repo rate can, depending on market conditions, represent an ask side of a currency, a ceiling. But that is one currency. Each nation must be understood due to the various factors to achieve its repo rate and the day-count factors of interest.Crisis economic conditions forced not only the normally reported and understood general collateral (GC) rate, but a government rate was established as borrowers were forced to borrow from central bank facilities. This chapter outlines all the various aspects of the Repurchase Agreement market from nation to nation. What was once a rate hidden from the market has, in the last 10 years or so, become a regularly reported rate with updated rates published periodically throughout any trading day.What were once popularly known as repos since the inception of central banks before World War I have now become known as Repurchase Agreements and reverse-Repurchase Agreements that serve a vital function of the daily operation of banking systems throughout the world.Traditionally, repos were employed as a monetary tool by central banks to add or subtract liquidity from the banking system as needed to manage the supply of money that flowed through banks. This was conducted through sales or purchases of respective nations’ treasury bonds, notes, and bills. When central banks bought repos or bonds, they added liquidity, and they drained liquidity when they reversed the transaction. This occurred traditionally when rates were misaligned such as a misaligned Fed funds rate to other short-term interest rates or, as in days past, when the discount rate was misaligned with the prime rate to offer a U.S. example. The system was a simple process.
eBook - ePub- (Author)
- 2023(Publication Date)
- Wiley(Publisher)
Collateral uniqueness: The higher the demand for a specific security, the lower the repo rate. The most recently issued or on-the-run developed market sovereign bonds typically have the lowest repo rates in a given market.- Collateral delivery: Repo rates are usually higher when either the cash lent is undercollateralized or no collateral is provided to the funds lender.
3.2. Risks Associated with Repurchase Agreements
Repo markets are a widely used source of short-term funding, with relatively low borrowing costs relative to other financing available to banks and other financial institutions. However, Repurchase Agreements involve a number of structural risks, and excessive reliance on this form of secured financing under adverse market conditions can lead to financial distress or insolvency.Each repo contract participant is exposed to the risk that the other party is unable to meet its obligations. While the secured nature of repo contracts reduces risk due to the value of the underlying collateral, several risks are important to consider:-
Default risk: Default risk is the primary exposure under a repo transaction, despite the existence of collateral. Collateral received from less creditworthy parties is more likely to be tested under a default scenario and may face illiquidity, adverse price changes, and legal or operational challenges.
eBook - PDFAfter the Accord
A History of Federal Reserve Open Market Operations, the US Government Securities Market, and Treasury Debt Management from 1951 to 1979
- Kenneth D. Garbade(Author)
- 2021(Publication Date)
- Cambridge University Press(Publisher)
He thought the System could scrape by with purchases of other, less actively traded bills and coupon-bearing debt, Repurchase Agreements, and some runoff of Treasury balances at the Reserve Banks, but suggested that an additional instrument for injecting reserves would provide a welcome backstop. 24 Holmes recommended that the Committee authorize “back-to-back” repos, where the Desk would finance repo collateral that dealers sourced from customers. He reminded the Committee that “dealer financing needs lately have been minimal because of the heavy demand for Treasury bills and high dealer financing costs, and the Repurchase Agreement has not therefore been a feasible means of reserve supply”: 22 1965 Annual Report of Open Market Operations, p. 31. 23 1966 Annual Report of Open Market Operations, p. 8. The report went on to note that “market uncertainties, the general upward pressure on interest rates and downward pressure on securities prices, and the persistently high cost and limited availability of dealer financing all combined to make dealers reluctant over much of the year to maintain significant trading positions in securities.” 24 Minutes of the Federal Open Market Committee, June 28, 1966, pp. 27 and 29. Repurchase Agreements in the 1960s 357 However, we are quite certain if dealers were told in advance that Repurchase Agreements were available, they would be able to find the necessary collateral by arranging back-to-back Repurchase Agreements with either banks or other holders of Government securities who were looking for cash over a period of expected monetary stringency. This approach would not involve any change in the repurchase instrument. It would involve a change from our usual practice of relating Repurchase Agreements to dealer inventories to a use of the dealers as a channel to those holders of Government securities who have temporary cash needs and who would prefer not to sell Treasury bills or other Government securities outright.
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