Sell/buyback

We next consider the sell/buyback, which is economically identical to the classic repo but is described under different cash flow terms. 

In addition to classic repo there exists sell/buyback. A sell/buyback is defined as an outright sale of a bond on the value date, and an outright repurchase of that bond for value on a forward date. The cash flows therefore become a sale of the bond at a spot price, followed by repur-... 

A sell/buyback is a spot sale and forward repurchase of bonds transacted simultaneously, and the repo rate is not explicit, but is implied in the forward price. Any coupon payments during the term are paid to the seller however, this is done through incorporation into the forward price, so the seller will not receive it immediately, but on termination. This is a disadvantage when compared to classic repo. However there will be compensation payable if a coupon is not handed over straight away, usually at... 

The forward price is calculated only for the purpose of incorporating repo interest it should not he confused with a forward interest rate, which is the interest rate for a term starting in the future and which is calculated from a spot interest rate. Nor should it be taken to he an indication of what the market price of the hond might be at the time of trade termination, the price of which could differ greatly from the sell/buyback forward price. 

Note that in some markets the term repo is used to describe what are in fact sell/buybacks. The Italian market is a good example of where this convention is followed. 

A general diagram for the sell/buyback is given in Exhibit 10.8. 

We use the same terms of trade given in Exhibit 10.3 earlier but this time the trade is a sell/buyback. In a sell/buyback we require the forward price on termination, and the difference between the spot and forward price incorporates the effects of repo interest. It is important to note that this forward price has nothing to with the actual market price of the collateral at the time of forward trade. It is simply a way of allowing for the repo interest that is the key factor in the trade. Thus in... 

The Bank of England discourages sell/buybacks in gilt repo and it is unusual, if not unheard of, to observe them in this market. However, we use these terms of trade for comparison purposes with the classic repo example given in the previous section. The procedure and the terms of the trade would be identical in other markets such as Italy and Portugal where sell/buyback trades are the norm. In the Italian market for example, sell/buybacks are actually called repos. ... 

EXHIBIT 10.9 Bloomberg Screen BSR for Sell/Buyback Trade in 5.75% 2009, Trade Date 5 July 2000... 

Bloomberg users access a different screen for sell/buybacks, which is BSR. This is shown in Exhibit 10.9. Entering in the terms of the trade, we see from Exhibit 10.9 that the forward price is 104.605876. How-... 

If there is a coupon payment during a sell/buyback trade and it is not paid over to the seller until termination, a compensating amount is also payable on the coupon amonnt, usually at the trade s repo rate. When cal-... 

Fundamentally both classic repo and sell/buybacks are money market instruments that are a means by which one party may lend cash to another party, secured against collateral in the form of stocks and bonds. Both transactions are a contract for one party to sell securities, with a simultaneous agreement to repurchase them at a specified future. They also involve ... 

The supplier of cash being compensated through the payment of interest, at an explicit (repo) or implicit (sell/buyback) rate of interest. 

In certain respects however, there are significant differences between the two instruments. A classic repo trade is carried out under formal legal documentation, which sets out the formal position of each counterparty in the event of default. Sell/buybacks have traditionally not been covered by this type of documentation, although this is no longer the case as standard documentation now exists to cater for them. There is no provision for marking-to-market and variation margining in sell/ buybacks, issues we shall look at shortly. 

EXHIBIT 10.11 Summary of Highlights of Classic Repo and Sell/Buyback... 

We illustrate a stock loan where the transaction is stock-driven. Let us assume that a securities house has a requirement to borrow a UK gilt, the 5.75% 2009, for a one-week period. This is the stock from our earlier classic repo and sell/buyback examples. We presume the requirement is to cover a short position in the stock, although there are other reasons why the securities house may wish to borrow the stock. The bond that it is offering as collateral is another gilt, the 6.50% Treasury 2003. The stock lender, who we may assume is an institutional investor such as a pension fund, but may as likely be another securities house or a bank, requires a margin of 5% as well as a fee of 20 basis points. The transaction is summarised in Exhibit 10.12. 

In both classic repo and sell/buyback, any initial margin is given to the supplier of cash in the transaction. This remains true in the case of specific repo. For initial margin the market value of the bond collateral is reduced (or given a haircut ) by the percentage of the initial margin and the nominal value determined from this reduced amount. In a stock loan transaction the lender of stock will ask for margin. 

The repo market in Spain has a number of distinctive features. One of the most significant of these is that the market trades sell/buybacks... 

Italian repo remains predominantly sell/buyback because of taxation and other issues. These include the retail origination and emphasis of the transaction, and the fact that both legs of a repo may be treated as separate transactions and attract two lots of stamp duty. 

ISMA s Italian regional committee produced an annexe which adapts Annex III of the GMRA (which contains provision for sell/buybacks) for transactions involving an Italian party or Italian securities. 

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