Reverse Repurchase Agreements
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- เผยแพร่เมื่อ 8 พ.ย. 2024
- This video investigates the structure and substance of reverse repos and addresses a widely held misperception of the distinction between repos and reverse repos. Though the structure of the two transactions is almost identical, the motivations of each are quite different. Reverse repos are often entered into as a means of obtaining securities to deliver against short sale, as such they can be viewed as loans of securities collateralized by cash.
InsidersGuideToFinance.com
insidersguidetofinance
Many others could not say the difference you said about repo and reverse repo.Really appreciate😊
Thank you for your complimentary words. I hope you will find some of my other videos equally informative.
Very belated thanks for your kind words. Hope you find other vids on my channel equally informative. Stay tuned I hope to add a widely requested vid on equity repos in the next few weeks. Cheers, Doug
Thanks for the informative video. I think you’re going to see an influx of questions on this subject and how it pertains to a specific equity. My question is how do the banks turn US treasury RRs from the Fed into equity RRs for the hedges to use in satisfying short sale FTDs?
Understood the concept with utmost clarity..
I am very pleased that you found the vid informative. Thank you for your complimentary words. Cheers, Doug
i came here becos of GME, this guy deserves more sub
I'm pleased you appreciated the video. I hope find you others on my channel equally informative. The vids on your TH-cam page indicate you are interested in options trading. There are 2 vids on my channel dealing with implied volatility that may be of interest to you: "What's Volatility: Determination of Implied Volatility" and "Volatility II - The Primary Driver of Implied Volatility". I also intend to do a few vids on option Greeks (delta, gamma and theta) over the next month or so.
Needed this for work. Thank you so much for your time and effort in making this video. I will watch it and rewatch it many times, and hopefully will nail down. You are soooo good at this stuff. Please keep on going
Thank you, so much for this. Really well explained!!
Your gratitude and compliment are most appreciated. Glad you found the video informative and helpful.
Hi Doug,
If a hedge fund uses a reverse repo to obtain a security to cover their short position, how do they return the security back to the broker-dealer in that case?Would they go out to the market and buy it to deliver ? The Hedge Fund would do this because they would earn interest right ?
Excellent content by the way!
Thank you
-Kyle
Hi Kyle, Thanks for your complimentary words.
You're generally right. Since the security received by the hedge fund in the reverse repo (rr) must be returned at the close of the rr, it must be obtained from somewhere (e.g. purchased from any willing seller, obtained by taking delivery on a long futures position, exercise of a call on the asset the hedge fund owns, etc.).
A rr may or may not earn the hedge fund interest. As noted in the vid, rrs are primarily a way of borrowing securities more cheaply than alternative methods (usually). Unlike repos where generic collateral results in a common rate of interest for all repos of the same term, rr rates are heavily influence by the specific security the party reversing in the security is seeking (they have to obtain the exact security that was short sold). If that security is in high demand (i.e trading special) the interest rate on rrs will be lower or even negative (i.e. when the security is returned at the unwinding of the rr, the hedge fund will receive less money than it handed over at the initiation of the rr).
If a hedge fund is just looking to make interest (rather than obtain securities to deliver against a short sale) it would do a repo.
Hope this answer helps clarify things. Cheers, Doug
@@insidersguidetofinance1388 Brilliant, thanks !
Very well done, Sir.
Hi Ekuba(?), thank you for the compliment. Glad you found the vid informative. Have a great day! Doug
That's very helpful. Thank you for sharing.
Glad you found it helpful.
Brilliant vid!!
RR usage keeps hitting record high in recent weeks especially after Fed raised the RRP from 0% to 0.05% on Wed. So what is the implication? Does the "Hedge Fund" or whoever gets the Treasury from the Fed are betting on treasury sold off so they can buy it back at cheaper price? Or they simply just making extra interest through the security lending program by lending out the treasuries?
And why would banks want to participate in RRP if IOER now is 15bps versus 5bps on RRP? I am guessing banks can earn more than 10bps through RRP than IOER?
Appreciate your answer.
Thanx for your compliment on the vid. Slow to reply as I wanted to research what's up in repo market before responding.
Couple of things to note for clarity of following: The Fed's terminology re repos and reverses is opposite to the way those transactions are described from the perspective of market participants. Further "system repos" (i.e. repos and reverses by the Fed) are not included in volume statistics for the repo market.
A reverse repo (RRP) entered into by the Fed is the opposite of a private financial institution (e.g., hedge fund) doing a reverse repo (rr). In the case of Fed RRP, it is handing over securities and receiving money; when a hedge fund does a rr, it is handing over money and receiving specific securities. And their motivations are completely different. The Fed is doing it to drain reserves from the system, and it is paying interest on the cash the Fed it receiving from the counterparty. A hedge fund is typically reversing in securities to be able to deliver them to settle a short sale (though there are other reasons). And if the securities reversed in by the hedge fund are "trading special" the hedge fund may be getting a negative interest rate on its funds (i.e. the counterparty on the rr will "repurchase" the securities for less money than it received from the hedge fund when the transaction was initiated).
However, as indicated by your comment there is a connection between the Fed's action and what is afoot in the repo market. Over the past year repo market volume is up 50%+ (and that is below the peaks reached last November). The reason is likely that there is a lot of money sloshing around the US markets, and many holders, somewhat fearful of the prospects for the economy and financial markets, are looking for a safe place to park cash. Lending money and getting high credit quality collateral (vast majority of market repos use Treasuries, agency MBS or government agency debt securities) is about as safe as lending gets. (And naturally, despite being called a repo---which is the market name for a transaction formally titled "sale under repurchase agreement"---the transaction is a collateralized loan in all but name). So much money is going into repos that interest rates have been driven to 0%.
That spooked the Fed (more about that below). Consequently, to push short-term rates up, the Fed increased the rate it pays on RRPs and increased the amount of securities it is willing to "purchase" on the front end of those transactions. The hope presumably being, that by reducing the amount of money in the economy there would be less money institutions could put into repos. Between that and offering a higher rate financial institutions might earn on a competing instrument into which funds could be placed, short-term rate in general (and repo rates in particular) wouldn't drop below zero.
The Fed's actions are in part driven by fear of deflation, which it thinks may follow in the wake of negative interest rates. So by keeping rates above zero, there is less concern about deflation. (A grossly misplace fear BTW, since the Fed thinks deflation means slower GDP growth rates, a view not consistent with economic history.) Furthermore, the Fed's actions bespeak a policy schizophrenia of gigantic proportions. At the same time it is saying it will not raise short-term rates for another year or 2, IT IS RAISING SHORT-TERM RATES!!! Simultaneously, it is saying inflation is not a problem when annual inflation rates are higher than they have been in over a decade and likely to increase further. Hard to say exactly where the coming financial crisis will erupt (like the stock market debacle in 2000 or the mortgage market in 2007-8), but the action in the repo market is but another symptom that things are about to blow (although whether that takes 2 weeks, 2 months or 2 years is anybodies guess).
I got carried away with reply and didn't respond to your question re IOER vs RRP rate. Presumably banks would not be attracted to doing RRPs at a lower rate (though I think I saw that the RRP rate is now at .10%). However, RRPs can be conducted with a wider set of institutions (e.g., primary dealers---not all of whom are banks----,money market mutual funds, government agencies--they have short-term cash to invest too) than have access to earning IOER, a market in which only commercial banks can participate.
@@insidersguidetofinance1388 what happens if repo rates are driven up due to less money going into the repo? what will the fed do?
There are a lot of RRs happening in the US stock market right now. Is this normal market function or potentially indicitive of market trouble?
Reverse repos have been a regular transaction in fixed income markets for many decades. Equity reverse repos are much less common and they tend to be made more frequently in periods where professional traders (the primary users of these transactions) perceive speculative excesses that cause individual securities (or entire sectors) to be trading above their fair or intrinsic value. Equity RRs are an alternate, potentially cheaper than other ways, of borrowing stock to deliver on a short sale made to bet on an equity value decline.
Like the run-up in crypto currencies, and unusually high earnings multiples at which many (especially tech) stocks are currently trading, if there has been an increase in equity repo activity it would be but another indicator of frothy valuations in many asset classes (at least, that is the view of many).
That is not to say the markets are about to crash (although I am 100% in cash), since markets and securities can trade well above fair value for a long long time. Alan Greenspan's infamous comment about the market exhibiting "irrational exuberance" was made in Nov/Dec 1996 and the 90s Tech Bubble didn't burst until March of 2000.
Thanks for viewing the vid and commenting. There are about 3 dozen vids on my channel (and more to come soon). I hope you find others to be equally interesting/thought provoking. Please recommend or share a link with friends/colleagues. Cheers, Doug
Get ready to go viral :D $GME
What's the largest amount the fed can do on the reverse repos? Even after rates are negative.
There are no statutory limitations on the size of Fed transactions. As an "independent" (in theory, private entity, since it is technically not part of the Federal government), entity the Fed itself, via its Board of Governors, decides what is appropriate.
A word of warning about Fed terminology. The Fed's uses the phrases "repo" and "reverse repo" exactly opposite to the meaning of those phrases when used by market participants. Per the vid you commented on, a reverse repo to a fixed income market participant means handing over money to reverse in securities. For the Fed a reverse repo means handing over securities to receive money. The Fed would do reverse repos to temporarily drain reserves from the banking system.
Naturally, that is what the Fed would do to prop up interest rates, or prevent them from falling (below 0%?). These Fed actions speak mostly to how confused/conflicted its policy goals are. The Fed has been ratcheting up the money supply to keep rates low. Now it doesn't want them to go too low. I suspect it has much to do with the association most Fed policy makers have made between negative rates and the deflation boogie man. It's too bad there are no economic historians on the Fed BoG or FOMC, just a bunch of believers in MMT (magical monetary thinking, oops, I mean Modern Monetary Theory).