Borrowing funds via repurchase agreements, Financial Management

Assignment Help:

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.


Related Discussions:- Borrowing funds via repurchase agreements

Operational cycle, using the operating cycle and any other financial manage...

using the operating cycle and any other financial management knoweledge,dicuss the applicability of such a cycle to the poultry biussiness in uganda (consider broilers)

No external financing for new proposals, No External Financing for New Prop...

No External Financing for New Proposals: If a firm have sufficient retained earnings with it as required by the new proposal, then the firm may not raise any external finance. In

Define the term- mergers and takeovers, Define the terms- Mergers and takeo...

Define the terms- Mergers and takeovers The terms takeovers and mergers are inter-related. When a company attains the majority of shares of another company, acquired company is

Effective duration and convexity of callable bonds, The modified dura...

The modified duration is a measure of the sensitivity of a bond's price to interest rate changes; the assumption made here is that the expected cash flow does not

Valuing mortgage-backed and asset-backed securities, A cash-flow yield is t...

A cash-flow yield is the discount rate that makes the price of a mortgage-backed or asset-backed security equal to the present value of its cash flows. It is built

Calculate the effective annual rate, The credit term from the supplier is 2...

The credit term from the supplier is 2/30, net 60. Question: Calculate the effective annual rate if the firm does not take the discount.

Explain the term- interest cover, Explain the term- Interest cover Int...

Explain the term- Interest cover Interest cover =Profit before interest and tax (PBIT)/ Interest payable(no. of times) Interest cover represents the safety of earnings tha

Simple arbitrage, Simple Arbitrage The easiest arbitrage opportunities ...

Simple Arbitrage The easiest arbitrage opportunities in the option market exist when options violate simple pricing bounds. No option, for example, should sell for less than it

Budget, what are the advantages and disadvantages of incremental budgeting?...

what are the advantages and disadvantages of incremental budgeting?

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd