7.21.2005

Q&A: If an investor needs to borrow funds for bonds purchase...

...what are some of the more common sources he can turn to?

  • Margin Buying: The funds are provided by the broker, and the broker gets the money from a bank using the same underlying bond as collateral.
    • The bank charges the broker an interest rate (known as call money rate, or broker loan rate), and the broker charges the investor the call money rate plus a service charge.
  • Repurchase Agreement: It is the sale of a security with a commitment by the seller to buy the same security back from the purchaser at a specified price at a designated future date. It is actually a collateralized loan.
    • The difference between the purchase (repurchase) price and the sale price is the dollar interest cost of the loan. The implied interest rate is called the repo rate.
    • A loan for 1 day is called an overnight repo. A loan for more than 1 day is called a term repo.
    • When a non-dealer uses the repo market to borrow funds, it is called a reverse repurchase transaction; when a dealer uses the repo market to borrow funds it is called a repurchase transaction.

Bonus Points

  • Margin Buying is the most common collateralized borrowing arrangement for common stock but not the common borrowing vehicle for institutional bond investors.
    • In the US, the percentage of a bond's value that can be bought on margin is regulated by the Federal Reserve.
  • The repo rate is lower than the cost of bank financing, but credit risks are faced by both parties. It is like a forward market without a clearinghouse.

Category: C++ Quant > Debt

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