What is the 'Implied Repo Rate'

The implied repo rate is the rate of return that can be earned by simultaneously selling a bond futures or forward contract, and then buying an actual bond of equal amount in the cash market using borrowed money. The bond is held until it is delivered into the futures or forward contract and the loan is repaid.

BREAKING DOWN 'Implied Repo Rate'

The repo rate refers to the amount earned, calculated as net profit, from the processing of selling a bond futures contract, or other issue, and subsequently using the borrowed funds to buy a bond of the same value with delivery taking place on the associated settlement date. The implied repo rate comes from the reverse repo market, which has similar gain/loss variables as the implied repo rate, and provides a function similar to that of a traditional interest rate.

Understanding Repos

A repo refers to the repurchase agreements that, by arranging to buy and subsequently sell a particular security at a specified time for a predetermined amount, function as a form of a collateralized loan. Generally, a dealer borrows an amount of funds less than a particular bond's value from a customer and the bond functions as collateral. Since the amount borrowed is less than the value of the bond, the lending customer has a reduced level of risk if the value of the bond decreases before the repayment time is reached.

Settlement Date

Terms regarding when repayment of the loan is required, referred to as the settlement date, can vary. In many instances, the funds are only held by the borrower overnight, causing the transaction to complete within a business day. Longer terms can be made available, though the majority remain under 14 days in length.

In transactions between money market funds and hedge funds, a bank may participate as a form of middleman. This allows the money market funds, which are supported by cash, and hedge funds, which are traditionally supported by bonds, to smoothly move funds between entities.

The market upon which these transactions take place is referred to as the repo market. After the financial crisis of 2008, the size of the repo market saw a reduction of approximately 49%, spurred by the bank industry's reluctance to lend Treasuries. This, in turn, made it more challenging for investors in the repo market to find interested borrowers looking for cash.

Applications Outside of the Bond Market

All types of futures and forward contracts have an implied repo rate, not just bond contracts. For example, the price at which wheat can be simultaneously purchased in the cash market and sold in the futures market, minus storage, delivery and borrowing costs, is an implied repo rate. In the mortgage-backed securities TBA market, the implied repo rate is known as the dollar roll arbitrage.

RELATED TERMS
  1. Repurchase Agreement - Repo

    A repurchase agreement is a form of short-term borrowing for ...
  2. Repo 105

    Repo 105 was a type of loophole in accounting for repo transactions ...
  3. Reverse Repurchase Agreement

    A reverse repurchase agreement is the purchase of securities ...
  4. Bond Fund

    A bond fund is a fund invested primarily in bonds and other debt ...
  5. Bond

    A bond is a fixed income investment in which an investor loans ...
  6. System Open Market Account - SOMA

    An account that is managed by the Federal Reserve Bank, containing ...
Related Articles
  1. Investing

    What is Reduced Bond Liquidity and Why Does it Matter Now?

    Reduced bond liquidity caused investor concern earlier in the year, but some signs point to a resurgence going forward.
  2. Investing

    Six biggest bond risks

    Bonds can be a great tool to generate income, but investors need to be aware of the pitfalls and risks of holding corporate and/or government securities.
  3. Investing

    Investing in Bonds: 5 Mistakes to Avoid in Today's Market

    Investors need to understand the five mistakes involving interest rate risk, credit risk, complex bonds, markups and inflation to avoid in the bond market.
  4. Investing

    How Interest Rates Impact Bond Values

    The relationship between interest rates and bond prices can seem complicated. Here's how it works.
  5. Investing

    The Best Bet for Retirement Income: Bonds or Bond Funds?

    Retirees seeking income from their investments typically look into bonds. Here's a look at the types of bonds, bond funds and their pros and cons.
  6. Investing

    Key Strategies To Avoid Negative Bond Returns

    It is difficult to make money in bonds in a rising rate environment, but there are ways to avoid losses.
  7. Retirement

    Money Market vs. Short-Term Bonds: A Compare and Contrast Case Study

    Discover characteristics of money market and short-term bonds, including how the investments are alike and different, and the benefits and risks each offers.
RELATED FAQS
  1. What's the difference between the prime rate and the repo rate?

    Learn about repo rates and prime rates and their differences. Explore the uses of these rates in consumer lending and managing ... Read Answer >>
Hot Definitions
  1. Financial Industry Regulatory Authority - FINRA

    A regulatory body created after the merger of the National Association of Securities Dealers and the New York Stock Exchange's ...
  2. Initial Public Offering - IPO

    The first sale of stock by a private company to the public. IPOs are often issued by companies seeking the capital to expand ...
  3. Cost of Goods Sold - COGS

    Cost of goods sold (COGS) is the direct costs attributable to the production of the goods sold in a company.
  4. Profit and Loss Statement (P&L)

    A financial statement that summarizes the revenues, costs and expenses incurred during a specified period of time, usually ...
  5. Monte Carlo Simulation

    Monte Carlo simulations are used to model the probability of different outcomes in a process that cannot easily be predicted ...
  6. Price Elasticity of Demand

    Price elasticity of demand is a measure of the change in the quantity demanded or purchased of a product in relation to its ...
Trading Center