can someone please explain to me what a repo agreement is? i cant seem to wrap my head around this
A Repo also known as a Repurchase agreement is a agreement between 2 parties where one sells securities to the other in exchange for money for an agreed upon tenor and and the end of the tenor the transaction is reversed Ex. A and B enter into a Repo agreement on 28th March 2010.A sells a security say 6.35% 2020 to B, for a period of 5 days at a repo rate of 5%.it means B has bought the security from A for 5 days and A has borrowed 10million from B @5% against the security. at the end of 5 days B will return the security to A and A will return the money. the working goes something like this…Its an example from a circular by RBI - India Central Bank on repo accounting guidelines. Security offered under repo :6.35% 2020 Coupon payment dates: 02 January and 02 July Market Price of security: Rs.90.9100 …(1) Date of the repo: 28-Mar-2010 Repo interest rate :5.00% Tenor of the repo :5 days Reversal date for the repo :02-Apr-2010 Broken period interest for the first leg :6.35% x 86 / 360 x 100 = 1.5169…(2) Cash consideration for the first leg: (1) + (2) = 92.4269…(3) Repo interest : 92.4269 x5/365x5.00%= 0.0633…(4) Cash Consideration for the second leg :(3)+(4) = 92.4269 + 0.0633 = 92.4902
Repo is a type of collateralized financing arrangement for bond purchases. In simple terms, the lender effectively buys the asset on behalf of the investor based on a repurchase assurance from the investor. From the lenders perspective both buying and selling prices are locked in per the repo agreement, which eliminates the price risk (subject to investor not defaulting). The difference represents interest on the lending. The investor’s purchase price is fixed (the repo price that they would pay to buy from the lender). The investor is thus hoping for leveraged profit from future upside. It might also be helpful to consider the following steps for a simplified example 1. Investor buys asset for $100, sells asset to lender for $100, investor net cash flow = 0, lender net cash outflow $100 2. At some point in future investor repurchases asset from lender for $110 (repo price), investor net cash outflow $110; lender has earned 10% return 3. Investor immediately sells asset for $115; investor has earned $5 without any cash payment upfront to purchase asset in step 1