REPURCHASE AGREEMENTS, or repos are short-term loans. In
a repurchase agreement, the security is sold with the seller agreeing to repurchase the security at a specified date and price.
On the flip side, a reverse repurchase agreement (reverse repo) occurs when the party on the other end of the transaction is buying the security and agreeing to sell it back in the future.
Hence the repo becomes a
collateralised loan, with the security being the collateral. The difference between the sale price and the repurchase price is the investor's return.
And while repos are considered collaterised loans, the interest rates paid on repos are not
determined by credit quality of the buyers and sellers in the transaction.
Market forces including the government and even the financial institutions themselves determine the interest rate offered on repos.
CONTROLLING MONEY SUPPLY
In fact, the Ministry of Finance and Bank of Jamaica make extensive use of reverse repos as a method of controlling the country's money supply. If there is too much money in circulation or if the local currency is under pressure, the Bank of Jamaica can offer several different repos or offer attractive interest rates on repos to influence investor behaviour. That is, they can make it more profitable to invest in a repo than to have the Jamaican dollar chasing after the greenback.
Alternatively, if a particular financial institution wants to entice persons to buy repos, they can offer rates that are a few basis points higher than the competition.
In its most basic form most repos are bought and sold overnight. Specifically, the repo is sold one day and repurchased the next. However, in Jamaica although you may find overnight repos, or short term repos of a week or less, most are structured for between one month to a year.
Repos are packaged and sold to investors who wish to earn on their cash at a higher rate than what is offered at a commercial bank.
HEDGE AGAINST DEVALUATION
And while it is important to have investments geared towards long-term planning, a repo allows for investors to make short to medium-term investment plans while benefiting from the cash flow from interest payments.
While repo transactions tend to be structured in large sums generally millions of dollars, brokers can package repos for their clients at different price points.
And repos can be bought in different currencies as well. Thus, investors can enjoy the cash flow from interest payments in several different currencies, which provides a hedge against devaluation.
And before investing in a repo, it is important to understand the different components of these types of securities.
Maturity generally from one day to 365 days.
Rate structure the yield earned based on market conditions.
Interest paid at maturity.
Security the security that backs the repurchase agreement, generally obligations issued by the Government of Jamaica or its agencies
Tax status the interest is taxable at 25 per cent.
Based on the information above, repos are best suited for short-term investments whereby you will earn on your investment while anticipating an upcoming expenditure. Therefore, it is best to discuss with your wealth manager the best way to incorporate repos into your portfolio.
We welcome your comments and feedback at
info@ncbcapitalmarkets.com or 1-888-4WEALTH.
