The Business of Investment Banking

By K. Thomas Liaw | Go to book overview

12
Repurchase Transactions

Repurchase agreements (repos) are extensively used in dealer financing, customer funding, and matched book trading. The repo desk has become the hub around which revolve the trading, hedging, and arbitrage strategies. At many firms the repo desk has become a key profit center. In addition, understanding the market is essential to assessing value in the securities markets. For example, the status of a bond in the repo market can be used to understand the relative values between bonds and also to assess the valuation of futures contracts. This chapter first describes the structure, development, trading mechanics, and market practices. Subsequent sections cover the upper and lower bounds of special repo rates, and the brokering and matched book transactions. It is important for bankers to understand the clearing process, fail consequences, the PSA-recommended trading guidelines, and GSCC netting services as well. Finally, the chapter also examines key issues related to the emerging equity repos.


THE BASICS

The repo market is the biggest money market, with the estimated market at $17.5 trillion and turnover at perhaps $500 billion a day.1 This is much larger than the Fed funds and is the biggest short-term money market in the world. In July 1996, the Fed adopted changes to Regulation T by loosening its provisions on valuing certain securities pledged as collateral from the previous 50% to discretionary “good faith.” The relaxation of Regulation T will further benefit the development of the fixed-income repo market and will, together with the National Securities Markets Improvement Act of 1996, help give birth to the equity repo market.


Purpose of Repurchase Transactions

In a typical repo transaction, a dealer puts up liquid securities as collateral against a cash loan while agreeing to repurchase the securities at a future date. The start-leg, or leg one, is usually settled the same day. The close-leg, or leg two, repurchase is a forward transaction. A repo is, in format, a securities transaction, but is, in essence, a collateralized loan to finance the purchase of the underlying security. The repo markets are therefore often called financing markets.

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The Business of Investment Banking
Table of contents

Table of contents

  • Title Page iii
  • Contents v
  • Preface vii
  • Acknowledgments ix
  • 1: Investment Banking in Global Capital Markets 1
  • 2: Venture Capital Markets 9
  • 3: Mergers and Acquisitions 27
  • 4: Stock Underwriting 47
  • 5: Underwriting Fixed-Income Securities 72
  • 6: Asset Securitization 94
  • 7: Foreign Listing on Wall Street 111
  • 8: Euromarkets and European Markets 125
  • 9: Japanese Securities Markets 148
  • 10: Emerging Markets 167
  • 11: Trading and Trading Techniques 185
  • 12: Repurchase Transactions 203
  • 13: Financial Engineering 222
  • 14: Money Management 241
  • 15: Clearing and Settlement 261
  • 16: Securities Regulation and Ethics 275
  • 17: Investment Banking Trends and Section 20 296
  • Chapter Notes 309
  • Glossary 315
  • Index 325
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