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
Explain about the term- Contingent liabilities Under IAS 37 provisions, contingent assets and contingentliabilities, contingent liabilities aren't recognised in the financia

Homework 1. Suppose you deposit $18,000 into an account today that earns 6% interest per year, and you do not withdraw the money for 21 years. What will be the balance in the acco

You have the following limited information upon which to base your decision as to which is the better of two alternative funding arrangements: ? Alternative 1 is to arrange funding

Hedging Using Commodity Futures Producers of agricultural commodities are faced with price risk and production risk over a period of time and within a marketing year. In case o

Considerations for the financiers of MBOs Support of MBO will rely on various factors: The reason for sale of business. Is it falling on hard times? Is group divesting to co

2.5. Västerås Corporation plans to buy a truck for $40,000 and depreciate it fully over 5 years using straight-line method of depreciation. However, it plans to use it for 8 years


Question : One activity of the study phase is: "Establish Ground Rules for the Study and Design Phases". (a) What are ground rules? (b) When developing ground rules for a

1.  Find out the present value of Rs. 10,000 to be required after 4 years if the interest rate is 6%. 2.  A Firm can invest Rs. 10,000 in a project with a life of three years.

Explain how exchange rate fluctuations influence the return from a foreign market measured in dollar terms. Discuss the empirical proof on the effect of exchange rate doubt on the