An Introduction to Repo Markets
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Content
Foreword xv
Preface xvii
Preface to First Edition xix
About the author xxi
1 Introduction to Repo 1
Importance of repo 3
Market participants 4
The repo instrument 5
Characteristics of repo 5
Classic repo 6
Summary 11
The sell/buy-back 11
Stock lending 13
Other repo products 14
Tri-party repo 15
Hold in custody repo 16
Safe-keeping repo 17
Borrow/Loan versus cash 17
Bonds borrowed/collateral pledged 17
Cross-currency repo 18
Exotic repo structures 19
Selected references 20
2 Market Background 21
Discounting and present value 22
Compounding 22
Discounting 23
Compounding more than once a year 23
Internal rate of return 24
Money market instruments 24
Securities quoted on a yield basis 25
Securities quoted on a discount basis 26
Money market formulae 27
Overview of bond market instruments 29
Definition of a bond 30
Fair pricing of bonds and bond yield 31
The yield curve 33
Theories of the yield curve 34
Bond price/yield relationship 34
Accrued interest 35
Accrual conventions 35
Selected references 36
3 The Mechanics of Repo 37
Uses and economic functions 38
Funding positions 38
Covering short positions 39
Yield enhancement 41
Margin 41
Initial margin 41
Variation margin 43
Other repo mechanics 44
Repo dealing risks 45
Interdependent risks 45
Financial market risks 46
Dealing with risk 49
Selected reference 50
4 Basket Repo, Synthetic Repo and Structured Finance Repo 51
Basket repo 52
Illustration of basket repo trade: Malaysian Government securities 52
Illustration using structured finance securities 55
Synthetic repo via the total return swap 58
Structured funding vehicles: repo conduit 62
Securities repo conduit 62
Selected reference 66
5 The UK Gilt Repo Market 67
Introduction 68
Growth of market 69
Gilt repo and other sterling money markets 70
Impact on the gilt market 72
Market structure 73
Repo and stock lending 73
Market participants: market making in repo 73
Market participants: brokers 74
Market participants: end-users 74
Gilt repo and the yield curve 75
Impact of the yield curve 75
Hedging through repo 75
Patterns of trading 76
Maturities 76
Specials 76
Gilts settlement and CREST 78
CREST settlement 79
CREST reference prices 79
Delivery by value 80
Gilt repo code of best practice 80
Selected references 81
6 Overview of Repo Trading and The Futures Contract Implied Repo Rate 83
Trading approaches 84
Positive yield curve environment 84
Negative yield curve environment 85
Yield curve arbitrage 86
Other spread trades 87
Specials trading 88
Credit intermediation 90
Matched book trading 90
Hedging tools 91
Futures strip 92
Forward rate agreements 93
Interest-rate swaps 94
The implied repo rate and basis trading 95
Contract definition 95
Conversion factors 98
The cheapest-to-deliver bond 99
The implied repo rate 102
Hedging implications 106
Selected references 108
7 Repo and the Yield Curve 109
Zero-coupon rates 110
Discount factors and the discount function 110
Spot and forward rates: boot-strapping from the par yield curve 111
Spot rates and boot-strapping 111
Implied spot and forward rates 112
The Relationship between par, zero and forward rates 121
Exercises and calculations 122
Forward rates: breakeven principle 122
Examples 123
Forward rates and compounding 126
Forward pricing and repo 126
Selected references 126
8 The Global Master Repurchase Agreement 129
TBMA/ICMA Agreement 130
The Global Master Repurchase Agreement 131
Scope 131
Structure 132
Key principles 133
Title transfer 133
Master netting agreement 137
Margin maintenance 140
Negotiation of the GMRA 141
Margin maintenance 142
Failure to deliver 144
Condition precedent 145
Set-off 146
Automatic early termination 146
Product- and counterparty-specific amendments and additional annexes 147
Gilt Repo Legal Agreement 147
Select references 148
9 Accounting, Tax and Regulatory Capital Issues in Repo 149
Accounting, tax and capital issues 150
Accounting 150
Taxation 150
Capital treatment 151
Capital Adequacy Directive 151
CAD treatment for repo 152
Balance sheet implications 153
The Basel II Framework 153
Basel II Framework 154
Exercises 157
Answers to exercises 162
Case study: ABC Bank plc 169
Glossary 181
Appendix A Duration 186
Appendix B Basis Trading and the CTD Bond 188
Appendix C Volatility 190
Abbreviations 192
Index 194
