Money Markets & Repos

Money Markets are usually very short term instruments.

Debt Market is roughly divided into 2 kinds

Bond Markets -> Maturities > 1 year

Money Markets -> Maturities < 1 year

TBills are Money Markets and they mostly use actual/360 or actual/365 conventions.

Repos are another short term money market Instrument.

Repo : Repurchase Agreement

Short term contract between 2 parties to exchange cash for an asset with an agreement to reverse the exchange at a future point.

2 Parties will enter into Repo Agreement.

One Party will lend cash by take other party's security. 

Second party will agree to buy the security back at a predetermined date in the future by paying the cash + interest (Repo Rate) in the contract.

Usually Repo's are very short term and they buy back the very next day.

REPO is from the buyers perspective.

Reverse Repo is the same thing from the lenders perspective (Party who is lending cash)

Example of Repo

Suppose a bank enters into a REPO agreement with a Broker Dealer. 

On Monday March 18, Broker Dealer will purchase a $5 M US Treasury Note with a coupon rate of 4.5%. With Bond currently trading at $4.5M, Broker Dealer agreed to purchase at a price of $4.4M with a repo rate of 1.5% and both parties agreed to buy it back the next day.

Note in the above transaction, Broker dealer is buying the bond at a price (4.4M) less than its market value (4.5M). This difference below the market rate is called "Hair Cut". To protect the lender incase of a default.

Hair Cut : When the amount is lent less than the Market Value of the Security, it is called Hair Cut. Charging Hair Cut will mitigate the loss of Capital.

Overnight Repos: Repos that expire the next day are called Overnight Repos

Term Repos: Little longer term Repos than overnight are called Term Repos.