Leveraged Clients/Hedge Funds
Any institutions needing to raise cash in order to fund its bond positions can do so using the repo market. It provides a large and liquid alternative to borrowing cash via unsecured bank deposits to leverage customers like hedge funds. Moreover, the customer's cost of borrowing should be cheaper via repo - particularly if the securities have some value in the specials market.
Leveraging
Repo transactions are used to finance transactions, which institutions such as hedge funds would execute. For instance, a repo can be used to finance the hedge portion of a complex OTC transaction. Since hedges come in all shapes and sizes, this means that in some cases repo can be done in the currency of the original swap or option. In other cases, in order to pick up more yield or put on a different risk spin, a cross-currency repo could be used.
The usual pattern of financing a trade can be depicted by the following steps:
- Fund purchases security from trading desk
- Fund loans security to repo desk and agrees to buy it back in the future over an agreed term
- Repo desk gives Fund money (for loan) less haircut
Cheaper funding can be obtained if the collateral repo-ed is special. The fact that hedge funds can obtain funding via repo transactions also means that they reduce their reliance on bank lines. Repo can be transacted without the intermediation of commercial banks and so it avoids the bid-offer spreads that banks charge their clients.
Also, being active in the repo market has low capital under-pinning requirements. This is specifically useful for hedge funds since they lack the balance sheet strength necessary to borrow at or below usual funding rates.
Market Intelligence
For portfolio managers, the benefits and practical information from the repo markets can be valuable.
