Repo regulations are stringent because securities must be returned on the due date. Repo has two main uses: (1) to borrow funds or securities and (2) for traders to take interest rate views at low cost. Repo is a secured short-term lending agreement where one party sells securities to another and agrees to repurchase them later at a higher price, providing the buyer with a low risk return. It allows borrowing of funds or securities using collateral, and traders can exercise views on rate movements inexpensively. Repo is used globally by central banks to manage money supply.

1. Repo regulations are very stringent across the world because you borrow
others' securities and hence it has to be returned on the due date.
Why people do Repo?
Repo has two 3 distinctive use:
(1) Primary - (a) Borrow funds or (b) Borrow securities
Borrow Funds => If an entity has available collateral and falls short of
cash or wants to use the cash for better opportunity, the same security /
collateral can be used to source funds either from Central bank or/and
from the market by depositing the security with the lender of the funds.
In India (Repo can be done for very long period as well though 99%
transactions are very short term - mostly Overnight because the
possibility of RollOver)
Borrow Securities (Regulation allows entities having borrowed securities
in their Account as SLR securities for them as we follow a Sell and Buy
Back Repo) => (a) there may be shortfall in SLR holding of an entity => the
securities are required for SLR maintenance => Any SLR securities is okay
=> The entity can choose "Basket Repo" (General Collaterals) because no
specific security is chosen.
Suppose an entity has Short sell a Security. The naked short sell is not
allowed and the selling entity has to deliver by borrowing the security.
You have to choose the exact security for delivery => the entity has to go
to "Special Repo" window to borrow the security.
Suppose the entity has a Derivatives delivery outstanding where the
security to be delivered under the "Interest Rate Futures" contract.
(Typically a security which is "Cheapest to Deliver" is in high demand
during delivery time as market participants need the security for
delivery). In this case you will need a "Special Repo" to borrow the exact
security.
Repo Borrowing Rates:
(a) Depend on whether you are using Basket or Special. Typically Basket
Repo will be an aligned short term interest rate with the market as any
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2. Repo will be an aligned short term interest rate with the market as any
security can be used as collateral or any person can lend the fund and
receive any eligible collateral without any specific security.
(b) In Special Window - the Repo borrowing rate will depend on the
availability of the security. It can be 0 or it can be negative or positive. If
there are more entities willing to lend security (Special), then rate will be
aligned to the market. But Market Squeeze due to Repo is very much
rampant.
(2) Take a view on interest rate and exercise the view at low cost
Traders can take a future view on the direction of interest rate
movement and accordingly they can use this market for exercising that
view
Repo is a financing arrangement used primarily in the government
securities markets whereby a dealer or other holder of government
securities sells the securities to a lender and agrees to repurchase them
at an agreed future date at an agreed price which will provide the lender
with an extremely low risk return.
Such a transaction is called a repo when viewed from the perspective of
the supplier of the securities (the party acquiring funds) and a reverse
repo or matched sale-purchase agreement when described from the
point of view of the supplier of funds.
Repos are hybrid transactions that combine features of both secured
loans and outright purchase and sale transactions but do not fit cleanly
into either classification. The use of margin or haircuts in valuing repo
securities, the right of repo borrowers to substitute collateral in term
agreements, and the use of mark-to-market provisions are examples of
repo features that typically are characteristics of secured lending
arrangements but are rarely found in outright purchase and sale
transactions.
The repo buyer's right to trade the securities during the term of the
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3. The repo buyer's right to trade the securities during the term of the
agreement, by contrast, represents a transfer of ownership that typically
does not occur in collateralized lending arrangements.
Repos are popular because they can virtually eliminate credit problems.
Traced back to the birth of Federal Reserve System and to the inception of
the Bankers’ Acceptances market at the close of World war I (in 1918). In
1923, the Fed began to use short term repos against Governments as a tool
for altering bank reserves.
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Worldwide Central Bankers use Repos to moderate Money Supply in the
economy.
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Characteristics of RP Agreement
Maturities => Buy Date and Sell date => number of days for which Repo
is to be made
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Principal Amounts - FV of the security => Repo transaction, the actual
amount of cash against the transaction is a byproduct => Security FV are
lent or borrowed
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Yields => Repo borrowing or lending rate => the rate which is going to
be charged by the lender of funds to the Repo seller
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Determinants of RP Rates => short term interest rate structure,
availability of collaterals, demand for specific security, etc.
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Valuation of Collateral - this has to be done on daily basis and margins
have to be posted if provided in the agreement
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Master Repo Agreement => The whole world works around this global
document.
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Taking Margin and Marking to Market => On daily basis margin has to
be posted till a particular threshold
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Treatment of Accrued Interest => It is always a part of the calculation.
But if any interest / coupon is paid out during the life of the Repo, the
same has to be returned to the owner of the security / seller of the
security
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Credit Risk => each one takes the risk against other of not returning the
security / not returning the cash. But as Repo is fully paid out, hence no
credit risk arises.
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Right of Substitution => allowed if provided in the agreement
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4. Right of Substitution => allowed if provided in the agreement
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Re-Repo => allowed
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Trading of Repo security => allowed freely for the buyer of the security
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