The ActRip - Repo Rate and Reverse Repo Rate - 33 Ishtpal Singh(A), 94 Pallavi Mahajan(B), 158 Rini Dhiman (C)

INTRODUCTION(By Rini Dhiman (C))

A REPO rate is a repurchase agreement or is the sale of securities together with an agreement for the seller to buy back the securities at a later date. A repo is economically similar to a secured loan, with the buyer (effectively the lender or investor) receiving securities as collateral to protect him against default by the seller. The party who initially sells the securities is effectively the borrower. For the buyer, a repo is an opportunity to invest cash for a customized period of time (other investments typically limit tenures). It is short-term and safer as a secured investment since the investor receives collateral.

DISCUSSION(By Ishtpal Singh (A))

A REPO is equivalent to a cash transaction combined with a forward contract. The cash transaction results in transfer of money to the borrower in exchange for legal transfer of the security to the lender, while the forward contract ensures repayment of the loan to the lender and return of the collateral of the borrower. The difference between the forward price and the spot price is effectively the interest on the loan while one of the settlement dates of the forward contract is the maturity date of the loan.

The repo rate normally trades closely to money market rates. This is sometimes referred to as the general collateral rate. But sometimes a particular security is in demand for borrowing purposes. This is because there are many dealers who have gone short of that security.
In this situation the cost of borrowing the security increases and depending on supply and demand conditions the repo rate can fall significantly. It can end up several percentage points beneath the prevailing money market rates. And in extreme situations a negative repo rate can occur.
When the repo rate for a specific security falls like this the repo rate is called a special rate.

In addition to using repo as a funding vehicle, repo traders "make markets". These traders have been traditionally known as "matched-book repo traders". The concept of a matched-book trade follows closely to that of a broker who takes both sides of an active trade, essentially having no market risk, only credit risk. Elementary matched-book traders engage in both the repo and a reverse repo within a short period of time, capturing the profits from the bid/ask spread between the reverse repo and repo rates. Presently, matched-book repo traders employ other profit strategies, such as non-matched maturities, collateral swaps, and liquidity management.

CONCLUSION(By Pallavi Mahajan(B))

So After a long discussion by Ishtpal Singh, what I Thought now is

Repo Rate is the rate at which the bank gets temporary funds from Reserve Bank of India to meet the demands of the people they are facing for loans means RBI contributes short term money(loans) to the banks and these rates impact the liquidity(Debt paying ability) of the system.

If the RBI wants to make it more expensive for the banks to borrow money, it increases the repo rate; similarly, if it wants to make it cheaper for banks to borrow money, it reduces the repo rate.

Whereas Reverse Repo Rate is the opposite of repo rate. In this RBI take up the money from banks means RBI absorbs the liquidity from the banks in terms of Accountancy.

If the reverse repo rate is increased, it means the RBI will take the money from the bank and offer them to produce profits. As a result, banks would prefer to keep their money with the RBI for a long run.

References:

“Repurchase agreement”. Available at http://en.wikipedia.org/wiki/Repurchase_agreement. 16^th Oct 2011

“Repo Training Guide”. Available at http://www.barbicanconsulting.co.uk/repo. 16^th Oct 2011