REPO

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Repo or Repurchase agreement is a money market instrument, which enables short-term borrowing and lending against securities. Under the repo agreement the holder of the bond sells it with an agreement to repurchase the same at an agreed rate and date. The forward clean price is set at a level, which is different from the spot clean price by adjusting the difference between repo interest rate and coupon earned on the security. This transaction is nothing but a collateralized lending. For the lender of cash the securities sold by the borrower is the collateral and for the borrower of cash the cash received from lender is the security. The lender of securities (who is the borrower of cash) is said to be doing ‘repo’ and the lender of cash (who is the borrower of securities) is said to be doing ‘reverse repo’. Whether a transaction is termed as repo or reverse repo is determined by who initiates the first leg of the transaction. Repo transaction help in borrowing cash and tiding over short term deficits and reverse repo transaction helps in earning some return on the idle cash.

  1. Repo Basics:

    • A repo, or repurchase agreement, is a short-term money market instrument used for borrowing and lending funds against securities.
    • In a repo, the holder of a bond (usually the borrower) sells it with an agreement to repurchase the same bond at an agreed-upon rate and date.

  2. Forward Clean Price:

    • The forward clean price is set at a level different from the spot clean price. This adjustment is based on the difference between the repo interest rate and the coupon earned on the security.

  3. Collateralized Lending:

    • In a repo transaction, the securities being sold by the borrower serve as collateral.
    • For the lender of cash, the securities act as collateral, while for the borrower of cash, the cash received from the lender serves as security.

  4. Repo vs. Reverse Repo:

    • Whether a transaction is termed a repo or reverse repo depends on who initiates the first leg of the transaction.
    • The lender of securities (borrower of cash) initiates a repo, while the lender of cash (borrower of securities) initiates a reverse repo.
    • Repo transactions help borrowers obtain cash to cover short-term deficits, while reverse repo transactions help lenders earn a return on idle cash.

  5. Two Legs of Repo:

    • Repo transactions involve two legs: the first leg when securities and cash are borrowed, and the second leg when they are returned.
    • Settlement amount on the first leg includes the value of the securities at the transaction price and accrued interest.
    • Settlement amount on the second leg includes repo interest, accrued interest, and the return of the principal amount borrowed.

  6. Numerical Example:

    • You provided a numerical example to illustrate a repo transaction:
      • Trade date: 13th July 2004
      • Settlement date: 13th July 2004
      • Trade price: 108.50
      • Face Value: 100,000
      • Security: 12.5% 20-Sep-2008
      • Repo rate: 7.5%
      • Repo term: 2 days
    • You calculated the settlement amounts for both the first and second legs of the repo transaction.

  7. Repo Rate:

    • The repo rate, which is agreed upon in the repo transaction, is typically lower compared to the interbank borrowing rate because it involves collateralized borrowing.

Your explanation provides a comprehensive understanding of how repo transactions work and how they are used in the financial markets for short-term borrowing and lending purposes, with a focus on the calculation of settlement amounts and the role of collateral.

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