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
Credit analysis Assessment of creditworthiness depends on the examination of information relating to the new customer. This information is frequently generated by a third party

Why is capital budgeting analysis so important to the firm? The major goal of the financial manager is to maximize shareholder wealth. Capital investments along with positive N

What action(s) should be taken if analysis of pro forma financial statements reveals positive trends?  Negative trends? When examine the pro forma statements, managers habi

Can a company have a default rate on its accounts receivable that is too low?  Explain. A company could comprise a default rate on AR that would be referred too low if by liberal

Are there any ways to analyze and value seasonal businesses? Seasonal businesses can be valued by discounting flows using annual data, but this needs some adjustments. The righ

Restatement of investment appraisal In the following solution the tax allowances in relation to the initial outlay on equipment are evaluated separately. Other approaches are a

Joe's ice cream stroe has to decide whether to shut down this winter or stay open. His projected revenue is $1,200 per week. He has fixed costs (Mortgage, taxes, insurance, etc.) t

4. In the front of each folder were some handwritten notes that Meenda had made on Monday before he left. Give focus on the said notes.

Nature of Working Capital: Working Capital Management is concerned with the problems that arise in attempting to organize the Current Assets, the inter-relationship and Curren

Portfolio Management: Project Portfolio Management (PPM) is the centralized management of processes, technologies and methods used by project management offices (PMOs) and pro