Introduction to Repo Markets

Dr Moorad Choudhry is Head of Treasury at KBC Financial Products in London. He is a Visiting Professor at the Department of Economics, London Metropolitan University, a Visiting Research Fellow at the ICMA Centre, University of Reading, a Senior Fellow at the Centre for Mathematical Trading and Finance, Cass Business School, and a Fellow of the Securities and Investment Institute.

• Foreword xvPreface xviiPreface to First Edition xixAbout the author xxi1 Introduction to Repo 1Importance of repo 3Market participants 4The repo instrument 5Characteristics of repo 5Classic repo 6Summary 11The sell/buy-back 11Stock lending 13Other repo products 14Tri-party repo 15Hold in custody repo 16Safe-keeping repo 17Borrow/Loan versus cash 17Bonds borrowed/collateral pledged 17Cross-currency repo 18Exotic repo structures 19Selected references 202 Market Background 21Discounting and present value 22Compounding 22Discounting 23Compounding more than once a year 23Internal rate of return 24Money market instruments 24Securities quoted on a yield basis 25Securities quoted on a discount basis 26Money market formulae 27Overview of bond market instruments 29Definition of a bond 30Fair pricing of bonds and bond yield 31The yield curve 33Theories of the yield curve 34Bond price/yield relationship 34Accrued interest 35Accrual conventions 35Selected references 363 The Mechanics of Repo 37Uses and economic functions 38Funding positions 38Covering short positions 39Yield enhancement 41Margin 41Initial margin 41Variation margin 43Other repo mechanics 44Repo dealing risks 45Interdependent risks 45Financial market risks 46Dealing with risk 49Selected reference 504 Basket Repo, Synthetic Repo and Structured Finance Repo 51Basket repo 52Illustration of basket repo trade: Malaysian Government securities 52Illustration using structured finance securities 55Synthetic repo via the total return swap 58Structured funding vehicles: repo conduit 62Securities repo conduit 62Selected reference 665 The UK Gilt Repo Market 67Introduction 68Growth of market 69Gilt repo and other sterling money markets 70Impact on the gilt market 72Market structure 73Repo and stock lending 73Market participants: market making in repo 73Market participants: brokers 74Market participants: end-users 74Gilt repo and the yield curve 75Impact of the yield curve 75Hedging through repo 75Patterns of trading 76Maturities 76Specials 76Gilts settlement and CREST 78CREST settlement 79CREST reference prices 79Delivery by value 80Gilt repo code of best practice 80Selected references 816 Overview of Repo Trading and The Futures Contract Implied Repo Rate 83Trading approaches 84Positive yield curve environment 84Negative yield curve environment 85Yield curve arbitrage 86Other spread trades 87Specials trading 88Credit intermediation 90Matched book trading 90Hedging tools 91Futures strip 92Forward rate agreements 93Interest-rate swaps 94The implied repo rate and basis trading 95Contract definition 95Conversion factors 98The cheapest-to-deliver bond 99The implied repo rate 102Hedging implications 106Selected references 1087 Repo and the Yield Curve 109Zero-coupon rates 110Discount factors and the discount function 110Spot and forward rates: boot-strapping from the par yield curve 111Spot rates and boot-strapping 111Implied spot and forward rates 112The Relationship between par, zero and forward rates 121Exercises and calculations 122Forward rates: breakeven principle 122Examples 123Forward rates and compounding 126Forward pricing and repo 126Selected references 1268 The Global Master Repurchase Agreement 129TBMA/ICMA Agreement 130The Global Master Repurchase Agreement 131Scope 131Structure 132Key principles 133Title transfer 133Master netting agreement 137Margin maintenance 140Negotiation of the GMRA 141Margin maintenance 142Failure to deliver 144Condition precedent 145Set-off 146Automatic early termination 146Product- and counterparty-specific amendments and additional annexes 147Gilt Repo Legal Agreement 147Select references 1489 Accounting, Tax and Regulatory Capital Issues in Repo 149Accounting, tax and capital issues 150Accounting 150Taxation 150Capital treatment 151Capital Adequacy Directive 151CAD treatment for repo 152Balance sheet implications 153The Basel II Framework 153Basel II Framework 154Exercises 157Answers to exercises 162Case study: ABC Bank plc 169Glossary 181Appendix A Duration 186Appendix B Basis Trading and the CTD Bond 188Appendix C Volatility 190Abbreviations 192Index 194