Most of you are aware of repurchase options (REPOS) a temporary Liquidity Adjustment Facility (Temporary need by RBI to Indian banks. Repo transactions, transactions also taking place between RBI and primary dealers, banks to banks, banks to other counterparties, primary dealers to primary dealers and primary dealers to other counterparties.
In the money market, internationally repos are classified as the ‘buy-sell back repo’, ‘classic repo’, ‘hold in custody repo’, ‘bond borrowing and lending’ and ‘tripartite repos’. The repos are classified as above on the basis of maturity of underlying securities, pricing, term of repo etc.
Buy-Sell repo: In buy-sell repo the security is sold outright and bought back simultaneously by the holder of security (borrower) for settlement on a later date. The investor (lender) actually takes possession of the collateral and hence he retains any coupon interest due on the bonds. The forward price of the bond is set in advance by adjustment of repo interest/ coupon yield earned by the investor on the underlying security.
Classic repo: In this type of repo transaction the seller repurchases the financial assets at the same price at which it was sold and makes a separate payment of interest. Here the securities actually are only collateral for the loan amount and coupon income will be accrued to the seller of the security.
Hold in custody repo: In this type of repos the counterparties enter into agreement wherein the seller holds the custody of sold securities intended for the buyer until maturity of the repo. Thus, the process of hold in custody repo eliminates settlement requirements.
Bond lending/borrowing transaction: The investor on the bonds lends his bonds for an open ended or fixed period in return for a fee. The fee charged would depend on the term of the loan, credit rating of the counter party and type of underlying securities and its size. The counterparties enter into an agreement in this type of securities lending. The cash or other securities of equal value could be offered as collateral in the transactions.
Tripartite repo: In tripartite repo a suitable financial institutions to intermediate between the lender and the borrower. The tripartite repo operates under DvP (Delivery versus Payment) settlement system that stipulates that cash payment must be made prior to or simultaneously with the delivery of the securities. A common custodian/clearing agency arranges for custody clearing and settlement of repos transactions. The system operates with signing of Global Master Repurchase and Tripartite Repo Service agreements by all the stake holders. This type of arrangement minimizes credit risk as the single agency takes care of the risk on itself and also undertakes substitution of securities, automatic roll overs marking to market, reporting and daily administration etc. Normally, the service of common custodian/clearing agency is utilized when dealing with clients with low credit rating.