Fixed Income Securities, 4th Edition

CHAPTER 10Repurchase Agreements and Financing

The repurchase agreement or repo market might be the most important market about which most people know little or nothing. Money market funds (MMFs) and other investors rely on repo as a short‐term, liquid asset; broker–dealers and other financial entities use repo to fund their inventory of securities; repo enables market participants to take short positions in fixed income markets; and, as described in Chapter 0, the Federal Reserve has historically and continues presently to use repo to conduct monetary policy. Finally, and most recently, interest rate derivatives and many loan products are transitioning from the London Interbank Offered Rate (LIBOR) indexes to the Secured Overnight Financing Rate (SOFR), which is derived from rates on repo transactions.

The first few sections of the chapter describe repurchase agreements, the uses of repo, and the structure and size of the market. A short section then describes the computation of the recently prominent SOFR, a rate featured in Chapters 2, 12, and 13. The subsequent section explains some of the determinants of the interest rates on both general collateral (GC) and special repo transactions. The penultimate section discusses repo in the context of financing risk, along with relevant changes in banking regulation. The final section is a case study of how MF Global fell in large part due to its inappropriately sized “repo‐to‐maturity” trades.

10.1 REPURCHASE AGREEMENTS

The most ...