P2.T7.513. Repurchase agreements (repos, Tuckman)

Nicole Seaman

Director of FRM Operations
Staff member
Learning outcomes: Describe the mechanics of repurchase agreements (repos)and calculate the settlement for a repo transaction. Explain common motivations for entering into repos, including their use in cash management and liquidity management.


513.1. At initiation of a repurchase agreement (repo), Counterparty A sells a security to Counterparty B for settlement on June 1st, 2015 at an invoice price of USD 180.0 million. At the same time, Counterparty A agrees to repurchase the security three months later, for settlement on September 1st, 2015, at a purchase price equal to the original invoice price plus interest at a repo rate of 0.90%. Using the actual/360 convention of most money market instruments, which is nearest to the repurchase price?

a. $414,000
b. $180,000,000
c. $180,414,000
d. $181,620,000

513.2. Rankcon is a repo investor in the money market mutual fund industry with the exclusive motive of cash management. As Tuckman explains, "Investors holding cash for liquidity or safekeeping purposes often find investing in repo to be an ideal solution. The most significant example of this is the money market mutual fund industry, which invests on behalf of investors willing to accept relatively low returns in exchange for liquidity and safety. [A money market fund would lend money while taking collateral and then, at maturity, collect the loan plus interest and return the collateral.]

Holding collateral makes the lender less vulnerable to the creditworthiness of a counterparty because, in the event of a default by the counterparty, the investor (e.g., the money market fund) can sell the repo collateral to recover any amounts owed. In summary, relative to super-safe and liquid non-interest-bearing bank deposits, repo investments pay a short-term rate without sacrificing much liquidity or incurring significant default risk." (Source: Bruce Tuckman, Angel Serrat, Fixed Income Securities: Tools for Today’s Markets, 3rd Edition (New York: Wiley, 2011))

Given this motivation, Rankcon understandably employs each of the following criteria (or preference) with respect to its repo investments EXCEPT which is the LEAST likely preference?

a. Rankcon insists on a sufficient (i.e., greater rather than lesser) collateral haircut
b. Rankcon only accept securities with the highest credit quality; e.g., debt of government-sponsored entities (GSEs)
c. Rankcon refuses to accept general collateral (at general collateral repo rates) and instead insists on particular securities with delineated asset classes
d. Rankcon places a premium on liquidity so tends to lend overnight rather than for term; or, if it wants to lend cash for an extended period, engages in an open repo

513.3. Consider the following illustration of a simplified repurchase agreement (repo) trade between generic Counterparty A and Counterparty B.


Please note this illustration refers to the initiation of the repo trade, not the unwinding. Consider the three primary motivations for a repo trade:

I. Lend funds short-term on a secured basis: A money market mutual fund who holds cash for liquidity or safekeeping purposes but who wants to lend the cash safely would BUY the repo as Counterparty B; because the fund is investing cash, the mutual fund is willing to accept general collateral
II. Finance the long position in a security: The trading desk at a financial institution who wants to finance the purchase of a security would sell the repo (aka, repo out) as Counterparty A using the purchased security as collateral
III. Borrow a security in order to sell it short: A hedge fund that wants to short a security but needs to borrow the security in order to sell it would do a reverse repo (aka, buy the repo) as Counterparty B; because the hedge fund is borrowing a bond, it does not accept a general collateral and instead requires delivery of a particular security

Which of the above is accurate (true)?

a. None are accurate
b. I. only is accurate (II. and III. are mistaken)
c. III. only is accurate (I. and II. are mistaken)
d. All are accurate

Answers here:
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