Repurchase Agreement (Repo)

In a repo, the fund sells securities (often government bonds) to a counterparty for cash and agrees to repurchase them at a set price on a set date; the difference is the repo interest. From the cash lender’s side the same trade is a reverse repo. Terms range from overnight to several months, and open repos roll daily until either side terminates. The cash lent is usually less than the collateral’s market value; the gap is the haircut, which protects the lender against price falls.

Funds use repo to finance leveraged bond positions, to borrow specific securities for short sales, or to invest surplus cash securely via reverse repo. Trades can be bilateral, tri-party (a clearing bank manages collateral selection and valuation), or centrally cleared. Documentation is usually the Global Master Repurchase Agreement (GMRA) or, in the US, the SIFMA Master Repurchase Agreement.

How funds account for repo. Under US GAAP and IFRS, a standard repo is normally treated as a secured borrowing, not a sale: the securities stay on the fund’s balance sheet and continue to earn coupons for the fund, while the cash received is recorded as a liability. Repo interest is accrued daily as an expense. A reverse repo is recorded as a receivable secured by collateral, with interest accrued as income. Collateral is marked to market daily, and margin calls move cash or securities to restore the agreed haircut.

Pitfalls. Common issues include booking a repo as an outright sale and repurchase (distorting positions and P&L), missing coupon payments that occur during the repo term (manufactured payments must be passed back to the original owner), unmonitored rolls on open repos, and repo rates that reset without being updated in the books. Positions under repo must be flagged as encumbered for liquidity and leverage reporting.

Example

A fund repos USD 20M face of Treasury notes worth USD 19.8M, receiving USD 19.4M cash (a 2% haircut) for 30 days at 4.30%. It accrues about USD 69,500 of repo interest (19.4M × 4.30% × 30/360) and repays USD 19.47M at maturity.