Repos: Facilitating a dealerís hunt for cash & securities
A dealerís debt equity-ratio may be of a magnitude that is as high as something like 40:1. That is for every $41 worth of securities being carried by him, $40 is funded with borrowed money. Repurchase agreements facilitate the borrowing by dealers to fund their inventories.
A repurchase agreement is essentially a collateralised loan agreement. Take the case of a dealer who has securities worth $100 and seeks to borrow. He can enter into an agreement with a party willing to lend, whereby he agrees to sell the securities for $100 with a simultaneous agreement to repurchase it at a slightly higher price.
As can be seen, this is essentially a collateralised borrowing arrangement. The difference between the sale price and the purchase price constitutes interest income for the party who is offering to buy the securities.
The securities themselves constitute collateral, for if the dealer who borrows reneges on his commitment to buy them back, the lender can have them sold to recover the amount lent. In some cases the sale and purchase price for the securities will be identical and the interest will be separately calculated and paid.
In practice, a dealer who offers securities that are currently valued at $100,
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