Repo (Repurchase Options)

Repo (Repurchase Options)
(Concept , Impact Analysis on Economy & Trends)



Technical Definition :


Repo is a financial agreement used primarily in the government securities dealt in money market or capital market whereby a dealer or other holder of such government securities sells the securities and agrees to re-purchase them at an agreed future date at an agreed price which will provide the lender with an extremely low risk return.

Reverse Repo is simply the same repurchase agreement from the buyer’s viewpoint, not the sellers. Hence, the seller executing the transaction would describe it as a “repo”, while the buyer in same transaction would describe it as a “reverse repo”.

So, Repo and Reverse Repo are exactly the same kind of transaction, just described from opposite viewpoints.



Understanding the Concept in Indian Economy Context :


Repo Rate is the rate at which the banks borrows from RBI. Whenever the banks have any shortage of funds to meet their current demand and term liabilities, they can borrow from RBI.

Reverse Repo Rate is the rate at which RBI borrows money from banks.

Repo Rate is the thus, the difference between borrowed and paid back cash expressed as percentage.


Differentiation from Loan Concept :


Although, the actual effect of whole transaction is identical to a cash loan, while using the “repurchase” terminology, the emphasis is placed upon the current legal ownership of the collateral securities by the respective parties.



Forms & Types of Repo Agreements/ Auctions :


Forms of Repo :

• Specified Delivery : It requires the delivery of pre specified bond at the onset and at maturity of the contractual period.

• Tri-party : This utilizes a tri-party clearing agent or bank and is more efficient.

• Held in Custody : This form is quite rare in development markets primarily due to risks associated with its nature.

Types of Repo Maturities :

• Overnight Repo : refers to one day maturity transaction.
• Term Repo : refers to a repo with specified end date.
• Open Repo : simply has no end date.


Securities settled in Repo Transactions/Auctions :

All transferable Government of India dated securities and Treasury Bills.

Minimum amount of Repo Transactions/Auctions :

Bids will be received for a minimum amount of Rs.5 crore and in multiples of 5 crore thereafter.

Participants in Repo Transactions/Auctions :

• All Scheduled Commercial Banks (excluding RRBs).
• Primary Dealers maintaining SGL and Current A/c with RBI.


Impact Analysis on Indian Economy :

The changes in Repo Rates or Reverse Repo Rates are likely to have impact across the sectors and can be enumerated as follow:

• Financial Sector - Banking / Credit System / Markets – Debt or Equity
• General Economy
• Industrial Sector
• Corporate Sector
• External Sector
Impact on Financial Sector – Banking / Credit / Markets (Debt or Equity)


The Central Bank of India (RBI) manages short – term falls and surpluses in the banking system through its LAF(Liquidity Adjustment Facility), whereby it borrows and lends money at fixed rates under the repo and reverse repo facilities.

Since, RBI technically has unlimited capacity to lend and borrow rupees, the repo and reverse repo rate act as a ceiling and a floor rate for the interest rates.

When RBI cuts the repo rate, it is in effect sends the signal that short term rates are too high and should come down. The central bank has been traditionally using the repo to signal short term rates and the bank rate to indicate its view on long term rates.

However, with the longer –term interest rates being increasingly driven by short-term money markets, the repo signal has been used to nudge banks to bring down their Benchmark Lending Rates.


Regulation of Money Supply / Liquidity in Monetary - Credit System :

To temporarily expand the money supply, the RBI decreases repo rates which will help banks to get money at cheaper rates while to contract the money supply, it increases the repo rates which makes the borrowings expensive.

Repo is the injection of liquidity by the RBI while Reverse Repo is the absorption of liquidity by RBI.

Due to this fine tuning of RBI using tools of CRR, Bank Rate, Repo Rate and Reverse Repo Rate, banks adjust their lending or investment rates, hence, infusing or diffusing liquidity in the Monetary and Credit system.

Impact on Markets (Debt /Equity) :

Bond Markets will be the biggest beneficiary as the rate cut will make it easier for banks to borrow short term money and invest in government securities at a marginal spread.

The rupee will weaken in the foreign exchange markets as Indian debt will be become less attractive for foreign investors.

The impact on Stock Market will be mixed as Equities are largely driven by portfolio flows, which in turn are largely unaffected by the central bank’s monetary measures.

Other Impacts :

Reduction in Repo Rates may lead to cut in :

• Floating Home Loan Rates / Consumer Loan Rates.
• BPLR (Benchmark Prime Lending Rates).
• May usher in a lower rate regime if liquidity stays easy.

While, Rising Interest Rates would mean higher EMI payments, this would, in turn affect consumer durable companies as well as financing companies.


Impact on General Economy

The interest rate hike will bring a general slow down in the economic activity as higher cost of funds would result in reduced consumption and investment expenditures. As a result, the aggregate demand will also get a hit.

Impact on Industrial Sector

The interest rate hike will increase the cost of raw materials and thus, high cost of funds which will result in reduced industrial investment. This could adversely affect the Greenfield projects.

Impact on Corporate Sector

With increase in rates, due to higher raw material cost and fuel cost, corporate profits are likely to go down. Reduced bottom line of corporate sector implies lower plough back of profits.

Impact on External Sector

Higher Interest Rates leading to Higher Interest Costs will adversely affect the competitiveness of the Indian Exports.

Changes in Repo Rates or Reverse Repo Rates could reduce the differential between the Fed Fund Rates (USA) and EU Main Operation Refinancing rates. Expectedly this could lead to higher capital inflows into India, leading to strengthening of the Balance of Payments situation.







Trends in Reverse Repo Rates (Year 2000 - 2008) :

Following is the chronology of Repo Rates since June 2000. The central bank of India (RBI) holds daily repo and reverse repo acutions as part of its Liquidity Adjustment facility. (Exemplary table attached in Annexure I).
-------------------------------------------------------
RATE (percent) EFFECTIVE DATE (Source : RB I)
-------------------------------------------------------
7.50 03-11-2008
8.50 24-06-2008
8.00 11-06-2008
7.75 30-03-2007
7.50 31-01-2007
7.25 30-10-2006
7.00 25-07-2006
6.75 08-06-2006
6.50 24-01-2006
6.25 26-10-2005
6.00 31-03-2004
7.00 19-03-2003
7.10 07-03-2003
7.50 12-11-2002
8.00 28-03-2002
8.50 07-06-2001
8.75 30-04-2001
9.00 09-03-2001
10.00 06-11-2000
10.25 13-10-2000
13.50 06-09-2000
15.00 30-08-2000
16.00 09-08-2000
10.00 21-07-2000
9.00 13-07-2000
12.25 28-06-2000
12.60 27-06-2000
13.05 23-06-2000
13.00 22-06-2000
13.50 21-06-2000
14.00 20-06-2000
13.50 19-06-2000
10.85 14-06-2000
9.55 13-06-2000
9.25 12-06-2000
9.05 09-06-2000
9.00 07-06-2000
9.05 05-06-2000
Annexure – I

Policy Rates & Reserve Ratios
(As on 09/11/08)



Policy Rates


Bank Rate : 6%

Repo Rate : 7.50%

Reverse Repo Rate : 6%



Reserve Ratios



Cash Reserve Ratio : 5.50%

Statutory Liquidity Ratio : 24%



(Source : www.rbi.org.in)



















Annexure – II (RBI Circular on Repo Dated November 3rd, 2008)


RBI/2008-2009/257
FMD.MOAG. No.28/01.01.01/2008-09
November 3, 2008

All Scheduled Commercial Banks (excluding RRBs) and Primary Dealers


Dear Sir,

Liquidity Adjustment Facility – Repo and Reverse Repo Rates


1.As already announced on November 1, 2008, the Reserve Bank has decided to reduce the fixed repo rate under the Liquidity Adjustment Facility (LAF) by 50 basis points from 8.0 per cent to 7.5 per cent with effect from November 3, 2008, in view of the ebbing of upside inflation risks as also to address concerns relating to the moderation in the growth momentum.

2. The reverse repo rate under LAF remains unchanged at 6.00 per cent.

3. All other terms and conditions of the current LAF Scheme remain unchanged.

Special Economic Zone units to be surveyed for Service Tax Compliance

Special Economic Zone units to be surveyed for Service Tax Compliance

SEZ units providing taxable services to recipients outside the special economic zones (SEZ) are under Government scanner. The revenue department officials have been directed to submit by October 31 a report on whether such units were discharging their service tax obligations or not. The report is to be submitted to the Director-General of Service Tax. The Central Board of Excise & Customs (CBEC) directive to survey the SEZ units follows a recent report of the Comptroller and Auditor General (CAG) which highlighted that certain SEZ units in Chennai and Kochi were providing taxable services such as manpower supply services, technical testing and analysis service to units / persons outside the zone without payment of service tax.

Taxable services received by SEZ units and SEZ developers for consumption within the SEZ are exempt from service tax. However, service tax is applicable on taxable services provided by SEZ units, except in situations where specifically exempted. In a communiqué to its field formations, the CBEC has said they should ensure that SEZ units, providing taxable services to any person for consumption in domestic tariff area, should register with the jurisdictional service tax authorities and discharge their service tax liability. Meanwhile, The Central Board of Excise and Customs has also clarified that Special Economic Zone units claiming refund of service tax should register with the jurisdictional service tax authorities.

“EARLY INVESTMENT-BETTER INVESTMENT”

INTORDUCTION:



Responsibility increases with the age and the capability of bearing the risk decreases. The capability of bearing highly strong risk is more incase of young persons and it will be very less in case of people who are about to retire or retired persons. Based on this, an investor has to make a plan for the investment.



Let us have a look at the investment portfolio based on ages.



According to the changing scenario, a lot of investment avenues have emerged to invest money .Out of that some may be of risky securities and some are risk less securities which provides returns to the investors at a given level of risk. At the time of preparing investment plan, age of the investor plays an important role. He is required to consider age, family and other factors at the time making investment .For example, an investor who has retired can make an investment in risk less securities which gives him a fixed income .In case if the time of retirement is more (young), they can make investment in risky securities where the return is also very high along with the risk.



The below table tells how to make an investment by taking in to consideration the factors like age, family , other constraints and so on. Basing on the needs and requirements, an investor can make modifications in the investment .the capability of taking risk differ from one investor to another investor. For Example, if an investor has more no of dependants, his capability of taking risk will be low and vice versa.



Investment avenues can be classified as Gold, Bullion, Fixed Income Securities, Equities and Mutual Funds .Among those Gold and Bullion are considered to be as highly liquid securities ,which also includes savings accounts of the bank. After shares, Fixed Income Securities and Mutual Funds play an important role in investment. Along with these, those investment securities which are prone to less risk also need to be given much importance.



I Age : 22-30 years

It is an age where the investor is single or married having no children. The number of dependents on the investor is also less where there will be a chance to mobilize more savings for the future. Annual income and the risk bearing capability of the investor will also be high. At this time, it is better to make investment in equity shares for a long time i.e. for 5 years. For an investor with in an age group of 22-30 years, the investment portfolio as follows:





22-30 years of age
%

Cash ,Bullion
10

Fixed Income Securities
30

Equity Markets
40

Mutual Fund-Equity Growth
20






II Age: 31-45 years

A stage where the number of dependants will be more children an other responsibilities will arise. More focus will be on protection of investment rather than on returns .The risk bearing capability of the investor will also decreases to certain extent . For the investor more priority will be towards children studies and mobilization of future savings and so on.



31-45 years of age
%

Cash ,Bullion
10

Fixed Income Securities
40

Equity Markets
30

Mutual Fund-Equity Growth
20






III Age: 45-60years

At this stage, more focus of the investor will be towards mobilizing of savings for higher education and marriage of children.He also focuses on future savings to lead his retirement life.Risk bearing capability of the investor will be zero and depending upon his needs ,he is required to change the investment portfolio accordingly.



45-60 years of age
%

Cash ,Bullion
10

Fixed Income Securities
50

Equity Markets
20

Mutual Fund-Equity Growth
20














III Age: Above 60 years

At this stage investor is more focused on enjoying his life with family or doing a part time leisurely work. The risk bearing capability is zero .For an investor at this time, it is better to hold less equity investments and hold more of fixed income securities to earn a fixed income which also ensures liquidity.





Above 60 years of age
%

Cash ,Bullion
10

Fixed Income Securities
70

Equity Markets
10

Mutual Fund-Equity Growth
10






Conclusion: Like this the investment portfolio changes depending upon the age of the investor The proportionate of investment may not be exactly but it may vary depending on the other constraints that are taken in to consideration by the investor.



“EARLY INVESTMENT-BETTER INVESTMENT”



For Example: An investor goal is to mobilize 10 lakhs after 20 years. For one year from now he has to make an investment of Rs14000/- Per annum. If he is willing to make investment after 10 years, he has to make an investment of nearly Rs 60000/- per annum. So get ready for savings at an early stage.

Minister Pranab to talk to PM on SEZ tax tangle

External Affairs Minister Pranab Mukherjee, who heads an Empowered Group of Ministers (EGoM) on special economic zones (SEZs), is likely to consult Prime Minister Manmohan Singh to resolve the dispute between finance and commerce ministries over tax exemption for export profits from the zones.



The EGoM has failed to arrive at a decision on the Income Tax Act’s Section 10 AA, which provides tax exemption on profits earned by units in SEZs.



While the commerce ministry wants export profits to be determined on the basis of the turnover of an SEZ unit, the finance ministry wants to take into account the company’s total turnover, including from the non-SEZ units. This, according to the commerce ministry, would reduce the exemption that was promised earlier.



The SEZ Act of 2005 provides the zones 100 per cent income tax deduction on export profits in the first five years of operation. But Section 10 AA says the export profit has to be taxed in proportion to the unit’s contribution to the company’s turnover.



Companies argue that the export profit of an SEZ unit should be computed in proportion to the turnover of the unit and not the entire company. This is because the present arrangement eats into the income tax deduction.



According to sources, the commerce ministry has been arguing that this is an anomaly, while the finance ministry says this is a conscious decision. “The finance ministry told the EGoM that the present arrangement will discourage shifting of existing work by companies to their SEZ units.



But the commerce ministry is saying there have been no cases of misuse,” said the source.

IT SEZs must wait for 100% tax exemption

IT may be a long wait for IT SEZs which are looking forward to a review of section 10AA (7) of the Income Tax Act for enjoying 100% tax exemption on profits.



The empowered group of ministers (eGoM) on special economic zones (SEZs), which met on Thursday, has not only deferred a decision on the need for a review, it is also now clear that a change in the section can only happen through an amendment to the Act. Since the Act can be amendment only by Parliament, any change in the current provisions could take several months.



Section 10 AA (7) of the Income Tax Act states that only a proportion of profits of a SEZ unit, based on the proportion of export sales from the unit to the total turnover of the parent company, will be exempt from taxation.



Under the SEZ Act, profits earned by the unit are 100% tax-exempt in the first five years and 50% tax-exempt for the next five years. Units are also eligible for 50% tax exemption on reinvested profits for another five years. “Section 10AA (7) is an aberration and that needs to be corrected

How to Calculate Sensex

The Sensex , an abbreviation of the BSE sensitive index, is a market capitalisation-weighted index of 30 stocks representing a sample of large, well-established and financially sound companies. It is the oldest index in India and has acquired a unique place in the collective consciousness of investors. The index is widely used to measure the performance of the Indian stock markets. Sensex is considered to be the pulse of the Indian stock markets as it represents the underlying universe of listed stocks on The Stock Exchange, Mumbai. Further, as the oldest index of the Indian stock market, it provides time series data over a fairly long period of time (since 1978-79). Sensex is not only scientifically designed but also based on globally accepted construction and review methodology. Sensex Calculation Methodology As per the methodology, the level of index at any point of time reflects the free-float market value of 30 component stocks relative to a base period. The market capitalisation of a company is determined by multiplying the price of its stock by the number of shares issued by the company. This market capitalisation is further multiplied by the free-float factor to determine the free-float market capitalisation. The base period of Sensex is 1978-79, and the base value is 100 points. This is often indicated by the notation 1978-79=100. The calculation of Sensex involves dividing the free-float market capitalisation of 30 companies in the index by a number called the Index Divisor. The Divisor is the only link to the original base period value of the Sensex. It keeps the index comparable over time and is the adjustment point for all index adjustments arising out of corporate actions, replacement of scrips etc. During market hours, prices of the index scrips, at which latest trades are executed, are used by the trading system to calculate the Sensex every 15 seconds and disseminated in real time.

Lehman Brothers - How ?

Lehman decided to play chicken with the market and they lost. In whats been likened to Black Monday (1987) today around 5,000 UK-based employees will lose their jobs as 158-year-old investment bank Lehman Brothers filed for bankruptcy protection under Chaper 11 of the US Bankruptcy Code. All of the employees in Londons Canary Wharf, as well as those at Lehman Brothers subsidiary, Capstone Mortgage Services in High Wycombe, are likely to find themselves out of a job. Ill now try to move into another industry, said one. Its a far cry from a year ago, when the bank was valued at some $47bn and was the largest trader on the London Stock Exchange. Eleventh hour discussions with Barclays and Bank of America faltered yesterday when it became clear the US government could not guarantee the troubled banks assets. It is, of course, the majority of Lehman Brothers 25,000 employees who stand to lose the most, along with 411,000 shareholders, George Soros among them he was among those who expected a rebound and doubled his shares in Lehman earlier this year. The Bank of England has made 5bn available and the European Central Bank added 30bn euros to keep liquidity flowing in the City. In a refreshing act of solidarity, 10 leading banks, including Credit Suisse, Citigroup and Deutsche Bank, are pooling their money to create an emergency borrowing fund of $70bn. Dr Housing Bubble blames Lehmans sub-prime mortage exposure. It is up in the air whether they held onto to these assets because of a foolish investment move or whether there simply wasnt a market for these assets. Plenty accuse CEO Richard Fuld (apparently nicknamed the Gorilla) of hubris, as well as for waiting too long to write off these bad bets. Greenlight Capitals outspoken David Einhorn raised alarm bells earlier this year about the banks lack of transparency when it came to declaring its liabilities. Other than the charismatic value of the leadership and maybe the popularity of the company, Lehmans exposures are worse than Bear [Stearn]s on an apples-to-apples basis, he told a reporter in June. It makes me rather sad to see this organisation brought to its knees as a result of what Ill call a lack of control, poor management of internal risk and ultimate self-interest, former Lehmans employee Walter Gerasimowicz told Bloomberg. (Its unfortunate, under the circumstances, that Fulds board positions include one for a charity called Robin Hood, targeting poverty in New York City.) The Reasoned Sceptic plays no favourites in apportioning blame. Lehman, Bear Stearns and Merrill Lynch all exhibited horrifically bad risk management in a sea of financial excess and excess capacity. Blame here goes straight to the board, then, whose members include Sir Christopher Gent. But theres a silver lining, says Anatole Kaletsky, arguing that the financial transactions between banks and hedge funds have less effect on the availability of credit to non-financial businesses than might be imagined. Had the US government bailed out Lehman or Merrill Lynch, there wouldve been a massive regulatory overhaul to appease taxpayers for having to take on the banks risks. As it is, the longer term effects are likely to be less drastic, argues Tracy Corrigan. But as investment banks cede supremacy to the commercial concerns, will the star system with its high bonus culture and short-term focus also go the way of the dinosaur?

Sub Prime Meaning

Sub-Prime Crises
Meaning of SubPrime :Meaning of sub prime commonly used where bank is landing a person at little bit higher rate than normal(prime) rate due to
• Loan to that person is little bit more risky than normal
• Person does not satisfy the condition for taking the loan
• less income than required
• Ratio of loan repayment /income is adverse
• Property involved is in area where rates of property is volatile and not stable
• Risk is high of repayment or some what speculative.
In brief they are landing to a person who is not otherwise eligible as per normal banking condition at higher rates.It does not mean that they are landing to any body without checking any thing but with a knowledge that risk is there, and due to more risk involved , they charge more interest from the party.These Type of loan generally mortgaged by Property or other assets.



If a lay man read this than he can also predict that the bank doing such practices will sooner or later have losses..........?but why the best brain of the world(so called) in US are unable to predict the crises. And Bank/companies which has never shown losses in their history of 140 years ,sank in one quarter losses..



Refinancing:Means bank giving loans directly to the customer,takes loan from other big company on the guarantee that they will pay back the money,as soon as it is received from the client.



Securitization :simple meaning of the securitization is giving loans out of balance sheet and have more cash to give more loan by transfer the mortgaged loans to special purpose vehicles (SPY) created for this purpose by the big houses. After securitization of mortgage assets ,Loan given will not shown in balance sheet and after securitisation of loans banks have good capital adequacy ratio and solvency margins, can give more loan ,but servicing/default risk of all loan remains with the institute and does not transfer to the SPV.



Step by step of reason of Crises
• The bank/companies which are giving loan at sub prime rates ,are small in the size.
• They have more specific information about the consumer and lend money to them on consideration other than financial .
• Then they have refinance their loans from the other big houses like Lahman ,Merrill lynch,AIG or other in the market
• With the money refinanced from the big company they gives more loan and so on
• They have given loan much more than what they have actually owned.
• Rates of property in USA is going south.And interest rates were going up.
• Some client which have Purchased property on loan for capital appreciation/or on the basis of some speculation like future increase in income , in the property was not able to return the loan
• Banks enforcing the foreclosures and taken the properties from the client or properties has been put to sale in the declining price market,Feeding more stock(property for sale) in the market and leads to further price fall
• Small companies collapses on default of some major customers as they are not able to manage cash flows.
• After default from customer they are unable to service the funds refinanced from big company.
• As I have explained above sub prime loans are more risky than normal ,this whole process of collapsing is so fast and have much cascading effect .
• The securitisation of laons also have a role as after securitization of laons companies have more clean balance sheet and one can not judge the Inherent risk involved in that due to less disclosures norms and other reasons.
• And we have now much longer list of casualties like Lahman Bros,Merill Lynch,AIG,Bear stearn,Fannie Mae and Freddie Mac...........and so on .This is not end of story more will come.
and more reason which leads to the crises is securitization ,simple meaning of the securitization is giving loans out of balance sheet and have more cash to give more loan by transfer the mortgaged loans to special purpose vehicle (SPY) prepared for this purpose by the big houses. After securitization of mortgage assets ,Loan given will not shown in balance sheet and after than they have good capital adequacy ratio and solvency margins, can give more loan ,but servicing/default risk of all loan remains with the institute and does not transfer to the SPV.