Lesson 4 of 6 · All lessons in this module
- Short-term bank funding: credit lines, secured loans and factoring
- Commercial paper, rollover risk and asset-backed CP
- How banks fund themselves: deposits, CDs and the interbank market
- Repo mechanics: repo rate, initial margin, haircut and variation marginVideo lesson
- Repos in practice: uses, repo rates, risks and triparty structures
- Long-term debt: investment-grade vs high-yield issuers
Lesson 4 of 6 · 15 min
Repo mechanics: repo rate, initial margin, haircut and variation margin
A repo is a collateralized loan dressed as a sale and buyback: the cash borrower sells a security today and buys it back later at a higher price, and the gap between the two prices is the interest.
In short
- Repurchase agreement (repo): sell a security now and agree to buy it back on the repurchase date at the repurchase price. The security seller is the cash borrower; the security buyer is the cash lender.
- Repurchase price = purchase price × : simple interest, usually on a 360-day year.
- The seller keeps the economic ownership: it still receives the coupons paid during the repo; the lender earns the repo rate.
- Initial margin = security price ÷ purchase price (above 100% means over-collateralized). Haircut = (security price − purchase price) ÷ security price.
- Variation margin = initial margin × purchase price at t − security price at t. Positive → borrower posts more collateral; negative → borrower can ask for collateral back.
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