1. Repurchase Agreements
“Capital Markets” -- Ch. 20
M Kim

2. Repurchase Agreements
The sale of a security with a commitment by the seller to buy the security back from the purchaser at a specified price at a designated future date.
collateralized loan
overnight repo: 1 day
term repo: more than 1 day

3. An example of repo transactions
dealer customer
borrow money lend money
give collateral accept collateral
“reversing out” “reversing in”
$10 million
of the bond

4. Repo rate Dollar interest
= Dollar principle * Repo rate * Repo term/360
The interest is computed on a 360-day basis.
Ex: overnight rapo rate = 6.5%
$ 9, * * 1/360 = $1805

5. Credit risks Practices to limit credit risk
The amount of loaned is less than the market value of the security used as collateral.
Mark the collateral to market on a regular basis.

6. Participants in the market
dealer firms
Ex: Borrow at 7.5% and lends at 7.55%, locking in a spread of 0.05%
repo broker
Federal Reserve

7. Determination of the repo rate
Quality
Quality , liquidity  repo rate
Term of the repo
Depends on the shape of the yield curve.
Delivery requirement
Delivery of the collateral to the lender is required  repo rate
Availability of collateral
More difficult to obtain the collateral  repo rate

8. Federal funds rate & repo rates
Federal funds rate determine the general level of repo rates.
The repo rate will be below the federal funds rate.
Typically the spread is about 25 basis points.

9. Federal funds Required reserves of depository institutions
No interest rate is earned on federal funds, because of an opportunity cost.
Commercial banks are the largest investors in federal funds.

10. Thank you!