By Omodele Adigun
Are you a dealer in FGN bonds, treasury bills and other government securities? Do you find it difficult financing the purchase of these securities? Then repo may be your best bet.
Repo is a money market instrument which stands for repurchase agreement. It is also known as sale and repurchase agreement. The Central Bank of Nigeria (CBN) defines it as “the sale of securities together with an agreement for the seller to buy back the securities at a later date.” The repurchase price is usually higher than the original sale price. The difference effectively representing interest sometimes called the repo rate.The party that originally buys the securities effectively acts as a lender.
thisMatter.com states that the securities serve as collateral for loan. “The difference between the repurchase price and the amount loaned is the amount of interest paid by the borrower to the lender,” the online platform adds.
The original seller is effectively acting as a borrower, using their securities as a collateral for a secured cash loan at a fixed rate of interest.
In a typical repo transaction, a holder of government securities (usually treasury bills or bonds) sells the securities and agrees to repurchase them at an agreed date in future at an agreed price. Repo transactions are usually of very short-term in nature, from overnight to 30 days or more. Repos are usually considered less risky due to their short-term maturity status and the backings from the government.
Reverse repo
Reverse repo is a complete opposite of a repo.In reverse repo, a dealer buys government securities from an investor, and then sells them back at a later date for a higher price.
Purpose
The main purpose of repo, according to thisMatter.com, is to finance the purchase of securities by government bond dealers until they can be sold to customers.
How it works
Since the apex bank sells its securities by auction, dealers must bid by specifying the price and quantity, and pay for successful bids by the settlement date.
However, the dealer may not have all the money on the settlement date, so if a dealer successfully bids for N200 million worth of Treasuries, the dealer may pay N100 million on the settlement date and finance the rest from the Treasury with the stipulation that they will be repurchased after the dealer receives payment from his customers. As the dealer sells more securities, more of the collateral is repurchased from the treasury for the bid price plus accrued interest on the security plus the interest that theTreasury charges for carrying the inventory.
Because most dealers can sell most of their inventory quickly, they only need to borrow money for a day or a few days at most, which is why the terms of most repos is very short.
Purchased securities
Purchased securities are the securities that the seller (borrower)must deliver to the buyer(lender) on the purchase date.The following securities are accepted: Nigerian Treasury Bills (NTBs); FGN bonds and Asset Management Corporation of Nigeria (AMCON) bonds.
Purchase price
This is the price at which the purchased securities are to be transfered from seller (borrower) to buyer(lender) on the purchase date.The price will be calculated using appropriate market yields and after applying the appropriate margin ratio.
Repurchase price
This is the price at which the purchased securities are to be transfered from buyer to seeller on the repurchase date. It is calculated using a money market formula.
Benefits
The mutual benefits of repo, according to thisMatter.com, is that it gives advantage to the borrower as repo rate is less than borrowing from a bank. “The main benefit to lenders over other money market instruments, such as commercial paper, is that the maturity of the repo can be precisely tailored to the lenders’ needs.