Repo
Consider the scenario wherein a dealer thinks a particular security’s price is about to rise but he does not have the cash to buy that security, then he can borrow the cash from the repo market(say from a bank) in exchange for lending the security. The dealer is said to be doing repo in this case. Here the securities will be transferred to the account of the lending Bank. These securities will be repurchased by the dealer at the end of the term. At the end of the term if the price of the security is increased then he can sell the security in the market to convert into a cash profit.
Carry
Carry refers to the profit or loss that made out of a repo. For a repo transaction, a security’s carry is the Profit/Loss, exclusive of capital gain, earned by the security and financing it with repo. Other words, carry is the difference between the coupon interest earned and the repo interest paid.
Carry can either be positive, negative, or zero.
Positive carry – When income from the asset being financed through a repo exceeds the cost of financing (i.e., repo rate plus expenses).
Negative carry – income from the asset being financed through a repo is less than the cost of financing.
Zero carry – income from the asset being financed through a repo is equal to the cost of financing.
Reverse Repo
A bank funds investors of stock market who feels that the current situation is suitable for investment but don’t have the cash in hand. In this case the bank is said to be doing reverse repo. Actaully in these transactions there are two parties one is doing repo and the other one is doing reverse repo. But the transaction is called repo/reverse repo based on the initiator of the first leg.
In the above example the shares are transferred to bank’s account. Usually banks lend only 70% (or less than 70%) of the funds required to avoid default risks. These are again transferred back to the investors. They are not popular in India.
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Sathish Emmadi
Sathish Emmadi is a co-founder & editor at Lastbull.com. He is presently working in IT for one of the world’s top mutual fund companies. Handled multiple projects in BFSI (Banking,Financial Services and Insurance) domain. An Engineering Graduate from NITW.
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