REPOS REPURCHASE AGREEMENT

1. FATIMA JINNAH WOMEN UNIVERSITY
ASSIGNMENT
ESSENTIAL OF BANKING MANAGEMENT

2. REPOS
REPURCHASEAGREEMENT

3. INTRODUCTION
Repos, short for repurchase agreements, are contracts
for the sale and future repurchase of a financial asset
On the termination date, the seller repurchases the
asset at the same price at which he sold it, and pays
interest for the use of the funds
They are usually very short-term, from overnight to
30 days or more than 30 days sometimes

4. DEFINITION
“A contract in which the seller of securities, such as Treasury
Bills, agrees to buy them back at a specified time and price.”

5. HISTORY
In US, repos have been used from as early as 1917 when
wartime taxes made older forms of lending less attractive
First repos were used just by the Federal Reserve to lend to
other banks
After fell away through the Great depression and WWII in
1920s, repos then expanded once again in the 1950s
Rapid growth in the 1970s and 1980s in part due to
computer technology

6. EXPLANATION
The annualized rate of interest paid on the loan is known as
the repo rate
Repos for longer than overnight are known as term repos.
repos that can be terminated by either side on a day’s notice
are known as open repos
the seller of securities does a repo and the lender of funds
does a reverse

7. EXPLANATION
The overnight repo rate normally runs slightly below the
Fed funds rate for two reasons:
First a repo transaction is a secured loan, whereas the
sale of Fed funds is an unsecured loan.
Second, many who can invest in repos cannot sell Fed
funds
By rolling overnight repos, they can keep surplus funds
invested without losing liquidity or incurring price risk
They also incur very little credit risk
Repos are classified as a money-market instrument
They are usually used to raise short-term capital

8. STRUCTURE AND TERMINOLOGY
A repo is economically similar to a secured loan
Highly liquid securities are preferred as they are more
easily disposed of in the event of a default
Collaterals used in a repo transaction are:
Treasury bills
Corporate and Treasury/Government bonds
Stocks

9. Securities are resold and coupons are paid to the seller
(borrower) at end of agreement
STRUCTURE AND TERMINOLOGY

10. TYPES OF REPURCHASEAGREEMENT
Term:
Term refers to a repo with a specified end date.
Open repo:
Open simply has no end date. In these agreements the
buyer (the cash lender) or seller (a collateral provider) can
terminate the repurchase agreement at any time.

11. IMPORTANCE OF REPOS
Repos are similar to Federal Funds except that Non-Banks
can participate
Repos are utilized by central banks as an indirect instrument
of monetary control for absorbing or injecting short term
liquidity.
Fed buys or sells Treasury securities in the repo market to
adjust the bank reserves.

12. FORMSOF REPOS
Specified delivery:
It requires delivery of the bond at the start and at maturity of
agreement.
Held in custody:
A repo in which securities sold are held in custody by the seller
for the buyer until maturity.
Buy-sell repo:
In a buy-sell repo the ownership is passed on to the buyer and
hence he retains any coupon interest due on the bonds.

13. • Tri-party:
INVESTOR
(Money
Market
Fund)
1. Cash
balance sent
to custodian
TRI-PARTY
SECURITIES
AGENT
2. Dealer sends
eligible securities
to custodian
3. Agent releases
cash to dealer
REPO
DEALER
FORMSOF REPOS

14. FORMSOF REPOS
6. Agent returns
cash & interest
to money
market fund
TRI-PARTY
SECURITIES
AGENT
4. Dealer
returns cash &
interest at end
of term
5. Agent sends
eligible
securities to
the dealer

15. MAJOR BORROWERSAND LENDERS
Borrowers:
Government bond dealers of Treasuries
Large banks
Lenders:
State and local governments
Insurance companies
Large banks
Non-financial corporations

16. REPO INTEREST INCOME
The difference between the underlying securities current
price and repurchase price is the amount of interest paid
by the borrower to the lender.

17. HOW REPURCHASEAGREEMENTSWORK

18. Why the owner sells bond to someone and repurchase it at
higher price?
The securities owner may need cash for a day or two, or a
week or more.
Instead of taking out a short-term loan, he can sell the bond or
stock to someone and promise to buy it back at a higher price.

19. Why would anyone want to own a security for such a short
time?
Consider a money-market fund with excess cash that it needs
to keep safe and provide a decent return on.
Its managers may be willing to transfer some of the cash for
a short time in exchange for a higher-yielding security, such as
a Treasury bond.

20. REPO MARKET
The over-the-counter repo market is now one of the largest
and most active sectors in the US money market
Dealers in securities use repos to manage their liquidity,
finance their inventories, and speculate in various ways.

21. REPO MARKET PLAYERS
Investors
Borrowers
Other institutions

22. REPO ARE NOT FORSMALL INVESTORS
The largest users of repos and reverses are the dealers in
government securities.
As of June 2008 there were 20 primary dealers recognized by
the Fed.
Many dealers do repos and reverses in at least one million
dollar chunks.
Big suppliers of repo money are money funds, large
corporations, state and local governments, and foreign central
banks.

23. WHO ELSE USES REPURCHASEAGREEMENTS
Central banks use repurchase
agreements to increase or reduce
the money supply. Companies, especially banks, may
participate in repo markets to make productive use of cash on
their balance sheets.
Repos are considered to be particularly safe, because the loan
comes with collateral.

24. REVERSEREPOS
“A purchase of securities with an
agreement to resell them at a higher
price at a specific future date.“
This is essentially just a loan of the
security at a specific rate.

26. Reverse repo is exactly the opposite of repo – a party buys a
security from another party with a commitment to sell it back to
the latter at a specified time and price.
The difference between the price at which the securities are
bought and sold is the lender’s profit or interest earned for
lending the money.
The terms of contract are in terms of a ‘repo rate’, representing
the money market borrowing/lending rate.
(Repo rate is the annual interest rate for the funds transferred
by the lender to the borrower.)
REVERSEREPOS

27. USES OF REPOS
For the buyer, a repo is an opportunity to invest cash for a
customized period of time.
For traders in trading firms, repos are used to finance long
positions.
Securities dealers are primary users of overnight repos.
The Federal Reserve also uses repos for open market operations
where they add or decrease reserves to the banking system by
trading in US Treasury Securities.

28. Although repo transactions are backed by collateral, i.e. the
lender can sell the securities to redeem the cash, a counter-party
risk exists.
In addition to using repo as a funding vehicle, repo traders
"make markets“. These traders have been traditionally known as
"matched-book repo traders”.
The concept of a matched-book trade follows closely to that of
a broker who takes both sides of an active trade, essentially
having no market risk, only credit risk.
USES OF REPOS

29. RISKINVOLVE IN REPOS
Repurchase agreements, known as Repos, involve the sale and
purchase of an asset at the same time. The assets used for Repos
are usually U.S. Treasury securities.
Repos are essentially short-term loans that banks use to fund
daily and weekly operations, and the risks involved include both
credit risk and market risk.

30. BUYER’SCREDIT RISK
The buyer in a Repo transaction incurs credit risk when
the deal is executed. If the seller, or counterparty, to the
trade goes bankrupt before the Repo matures, then the buyer
will be left holding the securities underlying the Repo trade.

31. BUYER’SMARKET RISK
Market risk in the context of Repos means interest rate risk. If
the counterparty to the deal goes bankrupt before maturity, then
the Repo buyer is exposed to the market risk caused by changes in
interest rates.

32. SELLER’SCREDIT RISK
The seller in a Repo trade also has credit risk. If the
counterparty goes bankrupt before the trade matures, then the
securities that were loaned to the buyer might get stuck in
bankruptcy proceedings and not returned to the seller.

33. SELLER’SMARKETRISK
In a mirror image of the market risk that the buyer assumes in a
Repo deal, the seller can lose money if interest rates decline before
maturity. If the buyer goes bankrupt, then the seller has an
amount of cash that will be lower than the value of the securities
that were loaned at the start of the trade.