Repos

Introduction

In this page, we will look at the money market for repurchase agreements, otherwise known as Repos. A Repo is a bilateral contract to sell and buy back securities. It has many uses in the market and is becoming increasingly popular among market professionals and their customers. The European Repo Council in their 14th Repo survey in April 2008 quantified the total value of outstanding European Repo contracts to be €6.382 trillion.
We will look at the most common structures used in the Repo market and how they are constructed. We will also look at the calculations used for the proceeds of the deals, consider why the market has sought to clarify the details of these deals by the adoption o a Standard Market Documentation.

What is a Repurchase Agreement?

A Repurchase Agreement is a Money Market Instrument whereby a borrower sells securities to another party and thus obtains funds, at a fixed price and agrees to repurchase the securities at an agreed future date and dirty price.
(The price of most securities is quoted ‘clean’ or without interests. This allows direct comparison with other securities prices. The ‘Dirty Price’ is the clean price plus interests).

Looked at this way, a repurchase agreement is effectively a secured borrowing, that is, the securities deposited with the lender for the period of the loan are used as collateral for loan.

A Repo is, in effect, a combination of two simultaneous transactions in one only contract.
One party sells and then buys back the securities (Repo), while the counterparty buys and then re-sells (reverse-Repo). Thus, whenever one side does a Repo, a Reverse Repo is transacted by another party.
The securities are sold in a Repo Agreement at current market prices and bought back with interests.

Advantages of Repos

There are a number of advantages of Repo:

Parties with a borrowing requirement can achieve lower funding costs through repos than with most other money market instruments.
Holders of securities can increase their overall returns by lending their securities through a Repo.
Repos are a low risk investment since they are secured by collateral and are usually transacted between parties with good credit ratings.
The cash and securities in a Repo transaction can be different currencies
For lenders of cash, repos provide a good alternative to both the unsecured money market and the outright purchase of securities.
For lenders of securities , any coupon interest on the securities is retained.
For both borrowers and lenders, repos represent a highly flexible and liquid instrument.
As repos are effectively collateralised loans, they carry a 0% Rw under Basel II.

Use of Repos

Repos are used to:

Finance long positions in different securities
provide an alternative source of finance to the unsecured money market
Provide a method of closing out short positions in a particular security

The most important use is to finance long positions.

Financing Long Positions

The unsecured money market is the section of the money market in which the borrower of funds is not required to provide security (collateral) to the lender of funds. Examples of unsecured money market instruments include T bills, CDs, and commercial paper.

Repos are primarily used to finance long positions in (mostly) Government securities. To do this, dealers sell these securities at an agreed IR in return. They use these funds to finance their purchases of these securities. They also agree to buy back the securities at an agreed price at some specified date in the future.

Closing out Short Positions

Dealers use reverse repos to close out short positions in a particular security. In this situation they purchase securities with a simultaneous agreement to sell them back at some date in the future. The increasing use of short selling has provided the opportunity for many institutions (such as insurance companies and pension funds) to dealers in the repo market.

Market Participants

Commercial Banks: tend to be the net sellers of collateral, that is cash borrowers
Corporations: together with money market funds tend to be net buyers of collateral (cash lenders)
Central Banks: enter the Repo market to influence IR in the short term. By buying collateral and lending funds, the Central Banks increase money supply and drive down IR

Calculating Repo Agreements

The mathematics used in the repo market is relatively simple. They are based on Standard Bonds Mathematics and IR and compounding.

Consider the following example:

A cash borrower repos USD 100m treasury 7.5% Mar 15 2018, to a cash lender for value Jun 13 2018, for 10 days at an agreed repo rate of 4%. The market price of the collateral is 100.50 and accrued interest is USD 1,849,315.07

Accrued Interest = Par Value of securities x coupon x (number of days accrued interest/days basis)

Start proceeds = [Par Value of Securities x (market price of collateral/100)]+Accrued Interests

Calculation:

Repo Rate 4%; term o trade = 10 days;

Start Proceeds: 100,000,000 x (100.50/100)+1,849,315.07 = 102,349,315.07

End Proceeds: Start Proceeds + Repo Interest

Repo Interests= Start Proceeds x Repo Rate x Term of trade/days basis

Repo Interests: 102,349,315.07 x 4% x 10/360= 113,721.46

End Proceeds: 102,349,315.07 + 113,721.46 = 102,464,036.53

Exercise review

Today is the 6th of June. The repo dealer at Cruj Bank has been asked to do some funding for the bank. The dealer need to raise about $50m and has been asked to see what rates can be achieved. As Cruj Bank is only looking for liquid money, the dealer is looking at the rates for one day and open repos.

The rates quoted on the screen are USD 3.10 – 3.15

If the dealer at Cruj bank wants to raise money, the rate to be used is 3.15%. The Market is offering to lend money, against collateral, at 3.15% and is looking to pay 3.10% for deposits.

When the dealer looks at the bank’s available collateral, he discovers that the bank doesn’t have $50m worth of securities on its books to use as collateral.
Instead it ha:

$30m Tbills 4.5% 11Nov 2018 trading at 100.50 clean price. Day count 26
€10m German Binds 5% 30 April 2019 trading at 99.89 clean price. Day count 37
€15m French OAT 4.75% 31 May 2019 trading at 99.45 clean price. Day count 6

The bank will have to use a cross currency repo and use Euro collateral in order to raise USD.

Cruj Bank decides to calculate how much it can raise using all securities and so it needs to look at EUR repo rate and the exchange rate for EUR/USD.

The first calculation involves the straightforward USD classic repo: start proceeds for the deal to repo out the USD 30m US Treasuries.

$30,000,000 x [100.50+(100 x 4.5%/2 x 26/184)]/100 = $30,245,380.43
this is the amount that can be borrowed against this collateral. The borrowing rate for this is the repo rate of 3.15%

Data:

$30m Tbills 4.5% 11Nov 2018 trading at 100.50 clean price. Day count 26
€10m German Bonds 5% 30 April 2019 trading at 99.89 clean price. Day count 37
€15m French OAT 4.75% 31 May 2019 trading at 99.45 clean price. Day count 6
Eur Repo Rate 3.50 – 3.55
USD Repo Rate 3.10 – 3.15
FX rate EUR/USD 1.2745

End Proceeds= €10m x [99.89+(100 x 5% x 37/184)]/100

€10m x [99.89+1.005434]/100 = €10,089,543 (amount that can be borrowed against the collateral)

The Eur German bonds proceeds will have to be converted.

€10,089,543 x 1.2745 = $12,859,123

End Proceeds = €15m x [99.45+(100 x 4.75% x 6/184)]/100

€15m x [99.45 + 0.15489]/100 = €14,940,733

The French Eur Bonds proceeds will have to be converted too.

€14,940,733 x 1.2745 = €19,041,964

Features of Repos

Maturity
Most repos are issued for one business day (overnight repos). In the US, this accounts for 70% of all repo transactions. However Repos with longer maturities are also common. These include: Term Repos: one day to one year) and Open Repos: either the borrower of the lender may choose to cancel at any time.
Margining
Margins are used to protect the lender, protect against the illiquidity of collateral and counterparty risk. In a repo transaction there are two types of margins: Initial and variation
Risk
Repo agreements are low risk transactions due to the following: They are fully collateralised loans, Provision for margining, daily Marking to market, Ownership of collateral
Collateral
The securities delivered as part of the repo agreement represent collateral and take one of the following forms: Specific and General collateral. Securities used as collateral include: Sovereign debt, Supranational debt, Money Market Instruments, Eurobonds

Margining

The fact that securities in a repo transaction can rise and fall in value means that some form of margin must be built in to protect the lender. Margin is also used to protect against the illiquid collateral and counterparty risk. In a repo transaction there are two types of margins, initial and variation.

Initial Margin is the percentage by which the market value of the securities (including accrued interests) in the repo transaction exceeds the cash lent (start proceeds). Margin is usually expressed as in terms of the margin ratio.
Margin ratio = Collateral Market Value/Cash Lent

For example, a margin of 2% represents a margin ratio of 102%. So if the collateral value is $10,000,000, (including accrued interests), cash lent will be:

cash lent = $10,000,000 / 1.02= 9,803,921.57

The seize of the IM is determined promarily by the credit worthiness of both counterparties and the securities used as collateral. In addition a longer repo term and higher collateral duration will lead to a higher IM.

The higher the IM received by the cash lender, the lower will be the rate received on the cash invested.

Variation Margin

VM refers to the amount by which the value of the collateralised securities may fluctuate before a margin call will be triggered. A margin call can be met in cash or by additional stock. Where several repo transactions have been made between two counterparties , margin calls are made on a portfolio basis on the overall net position.
VM can be expressed in percentage terms, in absolute cash amount terms, or on a discretionary basis by the counterparties.