Borrowing funds via repurchase agreements, Financial Management

Repurchase agreement is a contract wherein the seller of a security agrees to buy back the same security from the purchaser at a specified price and time. It is also known as repo or buyback. The price at which the seller agrees to buy back is known as repurchase price. And the date by which the security is to be repurchased is known as repurchase date. Repurchase agreement can be treated as a collateralized loan, where the collateral is sold and later re purchased. The security acts as collateral in repurchase agreements.

A dealer can use repurchase agreement or 'repo' market to obtain finance by pledging the purchased security as collateral to the loan. The interest rate the dealer agrees to pay is known as repo rate. The term of the loan, i.e. the date by which the dealer has to buyback the security and the repo rate are specified in the agreement. In an overnight repo, the term of the loan is one day, in a term repo the term of the loan is more than one day. The difference between the buyback price and the sale price is the actual interest cost of the loan.

Amount of interest depends on the repo rate, the term of the loan and the amount borrowed. The formula to calculate interest is as follows:

Interest = Amount Borrowed x Repo rate x Repo term/360.

Illustration 

Amount borrowed = Rs.30,00,000

Repo rate = 0.06

Repo term = 1 day

Therefore,

   Interest = Rs.30, 00,000 x 0.06 x 1/360 = Rs.500.

Dealers can reduce their cost of funding by using repo market for borrowing funds on a short-term basis. The cost of bank financing is higher than the cost involved while using repo market. To the customer, repo market offers better yield on a short-term loan and the highly liquid nature of the market makes it more attractive.

Reverse repo is an agreement where a buyer purchases securities with an agreement to resell them at a specified price (which is higher than the buying price) on a specified date.

Posted Date: 9/11/2012 1:40:18 AM | Location : United States







Related Discussions:- Borrowing funds via repurchase agreements, Assignment Help, Ask Question on Borrowing funds via repurchase agreements, Get Answer, Expert's Help, Borrowing funds via repurchase agreements Discussions

Write discussion on Borrowing funds via repurchase agreements
Your posts are moderated
Related Questions
Assume a bank charges a 15.5% APR (annual percentage rate) on credit card holder compounds quarterly. What EAR (effective annual rate) is the bank is charging? What if they change

Compare and contrast the book value and liquidation value per share for common stock. Is one method more reliable? Explain. The Book Value of a firm's common stock is institute

which type of financing is appropriate to each firm

Breaks in Specific Cost of Capital: The specific costs of capital may also be affected by the amount of finance the firm wants to raise. As the amount of financing increases, the

A firm has $700 in inventory, $600 in fixed assets, $600 in accounts receivables, $800 in accounts payable, and $50 in cash. What is the amount of the present assets?

In US, savings and loan associations constitute the major originating group of the traditional loans. What types of properties can be mortgaged?

Q. Working Capital as a Percentage of Net Sales? This approach to estimate the working capital requirement is based on the fact that the working capital for any firm is directl

Option-Adjusted Spread (OAS) The prime objective of an investor is to buy securities which have values greater than their market prices. The discussion made on the above valuat

what is financial management?

The managing directors of three profitable listed companies discussed their companies'' dividend policies at a business lunch. Company A; has deliberately paid no dividends for th