BROWSE

Implied Repo Rate

Definition

Implied Repo Rate is the rate of return of borrowing money to buy an asset in the spot market and delivering it in the futures market where the notional is used to repay the loan.

What is the 'Implied Repo Rate'

The implied repo rate is the rate of return that can be earned by simultaneously selling a bond futures or forward contract, and then buying an actual bond of equal amount in the cash market using borrowed money. The bond is held until it is delivered into the futures or forward contract and the loan is repaid.

Explaining 'Implied Repo Rate'

The repo rate refers to the amount earned, calculated as net profit, from the processing of selling a bond futures contract, or other issue, and subsequently using the borrowed funds to buy a bond of the same value with delivery taking place on the associated settlement date. The implied repo rate comes from the reverse repo market, which has similar gain/loss variables as the implied repo rate, and provides a function similar to that of a traditional interest rate.

Understanding Repos

A repo refers to the repurchase agreements that, by arranging to buy and subsequently sell a particular security at a specified time for a predetermined amount, function as a form of collateralized loan. Generally, a dealer borrows an amount of funds less than a particular bond's value from a customer and the bond functions as collateral. Since the amount borrowed is less than the value of the bond, the lending customer has a reduced level of risk if the value of the bond decreases before the repayment time is reached.

Settlement Date

Terms regarding when repayment on the loan is required, referred to as the settlement date, can vary. In many instances, the funds are only held by the borrower overnight, causing the transaction to complete within a business day. Longer terms can be made available, though the majority remain under 14 days in length.

Applications Outside of the Bond Market

All types of futures and forward contracts have an implied repo rate, not just bond contracts. For example, the price at which wheat can be simultaneously purchased in the cash market and sold in the futures market, minus storage, delivery and borrowing costs, is an implied repo rate. In the mortgage-backed securities TBA market, the implied repo rate is known as the dollar roll arbitrage.


Further Reading


Configurations for arbitrage using financial futures contracts
search.proquest.com [PDF]
… An approximation was presented for the implied repo rate for US Treasury bonds and financial futures … The sections on application considered arbitrage among implied repo rates and also money market rates … Repo Condor-Butterfly, Straight Repo, Turtle, and Euro-Turtle …

Arbitrage opportunities with T-bill/T-bond futures combinationsArbitrage opportunities with T-bill/T-bond futures combinations
search.proquest.com [PDF]
… An approximation was presented for the implied repo rate for US Treasury bonds and financial futures … The sections on application considered arbitrage among implied repo rates and also money market rates … Repo Condor-Butterfly, Straight Repo, Turtle, and Euro-Turtle …

Threshold cointegration and nonlinear causality test between inflation rate and repo rateThreshold cointegration and nonlinear causality test between inflation rate and repo rate
papers.ssrn.com [PDF]
… An approximation was presented for the implied repo rate for US Treasury bonds and financial futures … The sections on application considered arbitrage among implied repo rates and also money market rates … Repo Condor-Butterfly, Straight Repo, Turtle, and Euro-Turtle …

Japanese repo and call markets before, during, and emerging from the financial crisisJapanese repo and call markets before, during, and emerging from the financial crisis
www.sciencedirect.com [PDF]
… An approximation was presented for the implied repo rate for US Treasury bonds and financial futures … The sections on application considered arbitrage among implied repo rates and also money market rates … Repo Condor-Butterfly, Straight Repo, Turtle, and Euro-Turtle …

Interest rate setting on the Swiss Franc repo marketInterest rate setting on the Swiss Franc repo market
link.springer.com [PDF]
… An approximation was presented for the implied repo rate for US Treasury bonds and financial futures … The sections on application considered arbitrage among implied repo rates and also money market rates … Repo Condor-Butterfly, Straight Repo, Turtle, and Euro-Turtle …

In Which Direction Is There a Momentum Effect in the Changes in the Spread Between the Repo Rate and Federal Funds Rate?In Which Direction Is There a Momentum Effect in the Changes in the Spread Between the Repo Rate and Federal Funds Rate?
link.springer.com [PDF]
… An approximation was presented for the implied repo rate for US Treasury bonds and financial futures … The sections on application considered arbitrage among implied repo rates and also money market rates … Repo Condor-Butterfly, Straight Repo, Turtle, and Euro-Turtle …



Q&A About Implied Repo Rate


What does it mean to sell a bond futures or forward contract?

To sell a bond futures or forward contract means to enter into an agreement with another party where you agree to buy back the same type of security at a specified price on a future date.

What is a repo?

A repo is a form of short-term borrowing, mainly in government securities.

What is the implied repo rate?

The implied repo rate is the rate of return that can be earned by simultaneously selling a bond futures or forward contract, and then buying an actual bond of equal amount in the cash market using borrowed money.

How much do these transactions amount to per day?

An estimated $1 trillion per day in collateral value is transacted in the U.S. repo markets. sup id="citeref-NYTWSBuzz1-" class="reference" a href="citenote-NYTWSBuzz-1" &91;1&93; a sup sup id="citeref-FRBNYRepo2-" class="reference" a href="citenote-FRBNYRepo-2" &91;2&93; a .

What does the word "repo" stand for?

Repurchase agreement.

Why might one want to take out such a loan?

One may want such a loan if they believe that interest rates will rise and thus they could make more money by purchasing bonds now at lower rates and selling them later when interest rates are higher. This strategy also allows them access liquidity as well as diversification benefits since they can hold many different types of bonds instead of just one type like before taking out this kind of loan. It also gives them greater control over which bonds they wish purchase since they can choose which ones fit best with their overall investment goals rather than having only one option available like before taking out this kind of loan.

Where are these transactions conducted?

In 27–28, there was an event that caused panic on the repo market, which led to funding becoming unavailable or at very high interest rates for investment banks, which were then forced to sell assets quickly at low prices due to lack of capital from this source of funding..

What does it mean to buy an actual bond in the cash market?

To buy an actual bond in the cash market means to purchase from another individual who has already purchased said security from someone else.

What are some other names for repos?

RP, sale and repurchase agreement, or sale and repurchase.

Why did this happen during 27–28 ?

The run on the repo market was caused by concerns about counterparty risk—the risk that one party will not be able to meet its obligations under contract—and liquidity risk—the risk that one party will not be able to obtain cash

Who uses repos?

Large institutional investors such as money market mutual funds lend money to financial institutions such as investment banks either in exchange for (or secured by) collateral such as Treasury bonds and mortgage-backed securities held by the borrower financial institutions.

How do you repay your loan if you are borrowing less than what your collateral is worth?

You must pay back more than what was initially borrowed so that you have enough funds left over after repaying your loan for you to still have possession of your original collateral. If this were not done, then there would be no reason for anyone to borrow less than their collateral's value because they would not be able answer any potential losses incurred due to fluctuations in value.