An Introduction to Repo Markets by Moorad Choudhry

By Moorad Choudhry

The Repo markets have grown dramatically long ago few years a result of have to hedge brief positions within the capital and derivatives markets. nearly all significant forex markets on the planet now have a longtime repo industry, the ability is usually more and more getting used in constructing foreign money markets in addition.

This ebook is a pragmatic creation that makes a speciality of the tools, functions and chance administration ideas crucial for this speedily evolving marketplace. totally up to date to mirror the alterations in those markets, the e-book additionally contains labored examples and case reviews, and new sections on basket and based finance repo.

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THE MECHANICS OF REPO 41 Yield enhancement Active players in repo and interbank markets can enhance yield by lending bonds at the GC rate and then re-investing the cash at a higher rate. This would of course introduce an element of credit risk. A market counterparty could also borrow bonds in the stock lending market, on-lend these bonds via repo and invest the cash proceeds in, say, CDs. Where the collateral is government bonds, the institution will usually be receiving a higher rate on the CD than the repo rate it is paying in the repo.

The main function of these expectations is the expected rate of inflation. If investors are expecting inflationary pressures in the future, the yield curve will be positive (rising), while if they are expecting disinflationary pressures the yield curve will be negative or falling. The liquidity preference theory seeks to explain a positive-sloping yield curve as resulting from investors’ preferences to stay liquid. Since borrowers prefer to borrow long-term and lenders prefer to lend short-term, investors have to be compensated by a liquidity premium to forego liquidity over longer maturities, and this premium increases with term to maturity.

The holder of a zero-coupon bond realises interest by buying the bond at this discounted value, below its principal value. Interest is therefore paid on maturity, with the exact amount being the difference between the principal value and the discounted value paid on purchase. Floating rate bonds (FRNs) also exist. With these bonds coupon rates are reset periodically according to a predetermined benchmark, such as 3-month or 6-month LIBOR. For this reason FRNs typically trade more as money market instruments than conventional bonds.

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