What is Repo Trading and How Does It Work?

Repo trading is an important part of any functioning market. Essentially, dealers for bonds can buy bonds using customer’s money. The dealer posts the bond as collateral for the money borrowed. The repo market can refer to both the consumer level market, and also the central bank repo market. We will go over both repo markets in this article.

 

With the Repo Market It’s Important to Watch Out For Scams

One thing that is important to understand about the repo market, especially if you plan on letting dealers borrow your money, is that  there are a lot of scams involved. If you are planning to be involved in the repo market, you need to make sure that you are working with a reputable dealer, and that you read all of the fine print on the collateralization you are being offered.

 

Also, make sure you work with a reputable dealer whom other people have experience with. Unfortunately, a large number of scams have cropped up with shady companies using a variety of methods to steal money from people. Basically, the “dealer” will borrow your money and then give you fake collateral in exchange, or will use another method to give you fake bonds in exchange for your very real money.

 

The easiest way to avoid scams is to only work with major companies and established names in the industry. Often, the rates these reputable companies offer won’t be as substantial as smaller institutions, but in the long run they are generally much safer.

 

The most important thing when it comes to the repo market is to be diligent and to pay close attention. The repo industry has earned a bit of a bad rap over the past few years, but so long as you pay attention to what you are doing, it can actually be one of the safer markets to invest in because everything is collaterialized.

 

How Does a Reverse Rate Repo Work?

In some cases, you can have what’s called a reverse repo. In this case, a dealer will buy the bond from you, with you agreeing to rebuy it, usually within 24 hours or another short period of time. Basically, this allows people to free up liquidity and to use their bonds as short-term collateral.

 

Reverse rate repos are great for investors who have bonds, but need to free up liquidity for some reason. Perhaps you need some money to make a down payment, or to tide you over until a check clears. You could sell your bonds but you’d prefer to hold on to them as an investment. So instead, you can use your bonds as collateral and then take out a loan. The most important part of the agreement is the repurchasing agreement.  This repurchasing agreement requires you to buy the bond back. Thus, the lender gets their money back, plus a profit.

 

Reverse Repo as Collateralized Loans

Collateralized loans are great because they usually feature lower interest rates than comparable non-collateralized loans. This is because the collateral put forward lowers the risk. Most experienced investors know that risk is just about everything when it comes to investing and also loaning out money, which after all is an investment. The higher the risks, the higher interest rates banks and other lenders will want to charge.

 

If you can use bonds to secure your loans, however, you can get lower interest rates. Collateral is also why banks are able to offer low interest rates on cars and houses. If you stop making your car payment, the bank can repossess your car. The same with a mortgage, the bank can repossess your house. The same is true with a reverse repo, except it’s your bond that is offered up as collateral.

With reverse repo, you can use your bonds as collateral to free up some money for liquidity purposes. Your reverse repo rate will generally be quite reasonable because the bond will generally be more valuable than the amount you’re looking to borrow.

 

CRR, Repo Rates, and Central Banks

Repo rates and repo trading are also very important for central banks. Liquidity is very important and the repo market can offer you ways to increase liquidity at a relatively low cost. For banks, their cash-reserve-ratio, or CRR is also essential. Central banks set the required CRR, and banks must set aside money to meet the required stipulations.

 

Banks can use the repo rate set by the government to borrow money from the central bank. The reverse repo rate, on the other hand, is the rate at which central banks can borrow money from commercial banks. These concepts all tie together and are important for ensuring the overall stability of financial markets, as well as the flow of money within these markets.