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Strategies & Market Trends : India Coffee House -- Ignore unavailable to you. Want to Upgrade?

To: Mohan Marette who wrote (3563)	1/25/1999 12:09:00 PM
From: Mohan Marette	Respond to of 12475

Know your 'Repo' or Repurchase agreements. True not only for RBI but in general. What's a repo or repurchase pact? -------------------------------------------------------------------------------- REPO, repurchase agreement or a ready forward sale, are all terms for a sale and repurchase agreement in money markets. It is a transaction whereby banks and other financial institutions raise and invest short-term funds. Under this transaction a holder of securities (generally government bonds) sells them to an investor with an agreement to repurchase them at a fixed price on a fixed date. The security "buyer" in effect lends the "seller" money for the period of the agreement, and the terms of the agreement are structured to compensate him for this. Thus while the party which sells securities with a promise to buy them back is actually borrowing money, the purchasers of the securities in the first instance finds the repo a money market investment. Dealers use repo extensively to finance their positions. But when the Reserve Bank of India (RBI) is said to be holding a repo, it is selling securities to mop up funds from the banking system. Who are the players suitable to do a repo? Although there are no restrictions on the persons who qualify for entering into a repo transaction, by its very nature, such lending transactions are suitable for institutional players (mostly banks) who need an avenue to raise or invest large amounts for the short-term. However, when it comes to repos in government securities, the government has come up with very strict guidelines followi*ng the money markets scam. It has also limited the number of players who are allowed to do repos to very few market participants such as banks and primary dealers. What is the need for a repo transaction? Unlike a general borrowing or lending transaction in the money markets, repos are much safer as the lender holds government securities in his own name, and it is therefore a zero risk transaction for him. The second purpose it solves is that it helps banks in meeting their mandatory requirements for investing in government securities. Under the law, banks are required to invest a certain portion of their deposits in government securities. If their holdings are not up to the prescribed level, they are liable for punitive action. So if a bank needs securities for a short period, the repo provides an excellent opportunity. How is the interest on a repo calculated? Although there is no separate interest pay-out, there is an implicit interest cost in the form of the higher repurchase price. Thus the interest cost on the repo is calculated by dividing the difference between the sale and repurchase price by the initial sale price. What is the period for which a repo transaction can be held? This is an area in which there is a certain ambiguity. Although there are no legal restrictions on the tenure for a repo agreement, the Securities Contracts Regulation Act says that any agreement for the purchase of securities cannot be carried forward beyond 14 days. This means that the sale and delivery in a securities transaction should be completed within 14 days. Although this applies to direct sales of securities, for lack of legal clarity it is assumed that even repo transactions have to be restricted to 14 days. Why does the RBI hold repos? When the RBI announces a repo it has an entirely different objective. Following liberalisation, the RBI has decided to leave it to the market to determine the interest rate and also the exchange rate for the rupee. However, as the central bank, it is the RBI's job to maintain stability in the markets through interventions and open market operations. The repo is one such market operation by the Reserve Bank of India. When an RBI does a repo, what it actually does is remove excess funds from the market. At the same time, its repo rate also provides an indication of its view on what the interest rate should be. Sometimes, RBI also conducts a 'reverse repo'. This transaction has the opposite effect to that of a repo and infuses funds into the market. economictimes.com