Repo financing market Flashcards
What is repo market?
Repo market is lending contract that is based on collateral, which enables the money borrower to sell a collateral to money lender and promises to repurchase back at a higher price in the future.
Maturity - overnight repo or longer duration but less than a year is called term repo.
Open repo allows options to close at any date allowing settlement cost savings. However liquidity is concentrated on the shorter term money market.
Generally fixed income securities are used as a collateral, higher the quality of collateral lower the rate of return. (ABS was used often as a quality collateral, but now the rate required is high)
The difference between higher price and current money raised is called hair cut
Deficiencies in repo market?
- Over-reliance on repo market
Consider lending institution in MM, why would lend out at open maturity?
HIghly rated good quality institution borrow money in MM with low rate based on their credibility and lend back out in MM to at a slightly higher rate. They themselves have some borrowed money to pay in the future time so they say lets keep it open ????
What are the risks involved in open MM?
Risk arises mainly from market volatility, because overall credit worthiness of asset drops and therefosr less it is acceptable as a collateral ie the rate that lender can borrow increases, to mitigate this risk lender requires margin.
What went wrong in Repo makret?
I have MV of 100m worth asset, would I be able to borrow 100m at open market? Porbably not because lender will deduct a haircut on the basis of how the asset is credit worthy.
So therefore value of the collateral is dunamic which can change, that is what happened in MM in 2008.
Providers of refinancing kept reassessing MBS and ABSs and simply did not know what they were really worth and stopped lending money. Because they cannot assess the risk properly.
What is tri-party? is it dealing with OTC risk
Tri party repo is an incertision of a clearing agent in the middle of repo transaction and guaranteeing the trade as a middle man to reduce the OTC risk.
What are the benefits of repo?
Repo based borrowing is cheaper than non collateralised borrowing.
Financial institution use their asset to borrow money by doing repo contract, with that leverage they invest in some other asset and earn return while earning return on their assets that are put in as collateral as well.
Continue the process keep on borrowing and borrowing will earn return on all of these asset. However their borrowing cost will increase at each process (based on hair cut).
