Also known as a sell/buy back and often abbreviated to a Repo
This is classified as a money market instrument and not a derivative.
secured loans that dealers use to finance their fixed income inventory
Also referred to as bond lending.
Bond lending involves lending bond securities that you have on your books to other institutions for a fee.
Typically fully funded but they don't have to be.
It serves as a financing market for bond dealers, provides yield enhancement opportunities to portfolio managers
Repo terminology can be confusing. Technically, traders distinguish between repurchase agreements, or repos, and reverse repurchase agreements, or reverse repos or reverses. In practice, traders often say "repo" in either case.
For financing long positions
Obtain access to cheaper funding costs
To cover short positions
Banks want to buy bonds
The money is borrowed in the repo market to buy a bond
The bond is provided as the collateral
The position is funded with the repo rate
Banks want to short bonds
The bond is borrowed in the repo market (so it can be delivered on settlement date)
The money is provided as the collateral.
The accrued interest > the repo rate (positive net cost of carry)
When Banks short bonds, this can lead to free money because the accrued interest > repo rate Although there are risks (counterparty risk, mark to market profit/loss) Banks hold a large number of government bonds
Periodic repricing of the collateral is called margin calls
GC - General Collateral (group of bonds) SC - Specific Collateral (specific bond)
A repo is a repurchase agreement to sell some security to another party and buy it back at a fixed date and for a fixed amount
A repurchase agreement is a simultaneous sale and repurchase of a security at a specified price, interest rate and time.
There are 3 different types of repurchase agreement:
Overnight - one day maturity transactions
Term - (fixed term) which has a specific end date
Open - which has no specific end date.
Most repos are overnight transactions, but a liquid market exists out to six months, and repos are possible out to a year. All deals longer than overnight are "term repos" as they last a specific term.
Repos are typically short-term
Bonds are the most common security used a repurchase agreement and include government bills, government bonds and corporate bonds.
The price at which the security is bought back is greater than the selling price and the difference implies an interest rate called the repo rate
This is the difference between the borrowed amount and the amount paid back in cash, expressed as a percentage.
The commonest repo is the overnight repo in which an agreement is renegiated daily
This type of transaction is very similar to a loan
These instruments are used in the money markets and in capital markets
A reverse repo is the borrowing of a security for a short period of time at an agreed interest rate
Repos can be used to lock in future interest rates.
For example buy a 6 month treasury bill today and repo it out for 3 months
There is no cash flow today since the bond has been paid for (money out) and the repoed (same amount in)
In 3 months you will have to repurchase to bill at the agreed price
In 6 months you receive the notional.
A repo is a way of reducing the cost of lending
Sell the bond and get the cash.
Buy a bond - where do you get the money from
Need to sell a bond to generate the money (3 days later)
Sell a repo to get some of the money back
Sell a bond
need to buy a bond
buy the repo
reverse repo - buy the bond
buy sell back is equivalent to a repo
a sell buy back is equivalent to a reverse repo.
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