Definition
Purchasing an item in the spot market with borrowed funds and delivering it in the futures market where the notional is utilized to pay the loan is known as borrowing the implied repo rate (also known as the IMPLEMENTED REPO RATE).
What is the ‘Implied Repo Rate’
This rate of return is generated by simultaneously selling a bond futures or forward contract and then purchasing a real bond of equivalent value in the cash market using borrowed funds. Until the bond is delivered into the futures or forward contract, and the loan is returned, the bond is kept in escrow.
Explaining ‘Implied Repo Rate’
Refers to the amount generated, defined as net profit, from the procedure of selling a bond futures contract or other issue and then utilizing the borrowed money to purchase a bond of equal value with delivery taking place on the related settlement date, also known as the repo rate. Unlike the implied repo rate, which is derived from the reverse repo market, which has comparable gain/loss variables to those of the implied repo rate, the implied repo rate performs a function that is similar to the function of a conventional interest rate.
Understanding Repos
A repurchase agreement is a kind of collateralized loan that works by negotiating to acquire and then sell a certain asset at a given time for a preset sum. It is also known as a repo agreement. To borrow cash from an investor, a dealer often borrows an amount of money equal to a specific bond’s face value, with the bond serving as security. Due to the fact that the amount borrowed is smaller than the value of the bond, the lending customer is exposed to a lower degree of risk if the value of the bond declines before the maturity date of the bond is met.
Settlement Date
The settlement date, which refers to the day on which the loan must be repaid, might vary depending on the terms of the loan. Because the money are often only kept by the borrower overnight, the transaction is typically completed within one business day. Even while longer durations are possible, most are less than 14 days in length in the majority of cases.
Applications Outside of the Bond Market
Not just bond contracts, but also all other forms of futures and forward transactions are subject to an implied repo rate. An implied repo rate, for example, is the price at which wheat may be acquired in the cash market and sold in the futures market at the same time, less storage, delivery, and borrowing expenses, and is calculated as follows: The implied repo rate in the mortgage-backed securities TBA market is referred to as the dollar roll arbitrage in this market.
Implied Repo Rate FAQ
What is the meaning of repo rate?
It is the interest rate at which a country's central bank (in this example, the Reserve Bank of India) loans money to commercial banks when a country's central bank (in this case, the RBI) has a deficit in funds. The repo rate is a tool that monetary authorities employ to keep inflation under control.
What does negative repo rate mean?
An interest rate that is negative on a repo indicates that the buyer (who is lending cash) is effectively paying interest to the seller (who is borrowing cash).
What will happen if repo rate is increased?
When the repo rate rises, the cost of borrowing for firms rises as well, resulting in a decrease in investment and cash flow in the market as a result. In the event of a liquidity constraint in the economy, the Reserve Bank of India (RBI) lowers the repo rate, which lowers the cost of borrowing, hence boosting the amount of cash flowing through the economy.
Further Reading
- Configurations for arbitrage using financial futures contracts – search.proquest.com [PDF]
- Arbitrage opportunities with T-bill/T-bond futures combinations – search.proquest.com [PDF]
- Threshold cointegration and nonlinear causality test between inflation rate and repo rate – papers.ssrn.com [PDF]
- Japanese repo and call markets before, during, and emerging from the financial crisis – www.sciencedirect.com [PDF]
- Interest rate setting on the Swiss Franc repo market – link.springer.com [PDF]
- In Which Direction Is There a Momentum Effect in the Changes in the Spread Between the Repo Rate and Federal Funds Rate? – link.springer.com [PDF]
