Explanation:
This question involves understanding repo vs reverse repo transactions and calculating the repurchase price.
$25 million of accounts payable$25 million$27 millionContract Type: When a firm needs financing and posts collateral, it's engaging in a repo agreement. In a repo:
Reverse Repo would be the opposite - Pasquini would be providing financing to someone else
Repurchase Price Calculation:
$25,000,000$25,000,000 × 0.5% × (30/360) = $25,000,000 × 0.005 × 0.08333 = $10,416.67$25,000,000 + $10,416.67 = $25,010,416.67However, looking at the options:
$27,011,250 (which appears to be based on face value)$25,010,417 (which matches our calculation)But Option B has "Reverse Repo" which is incorrect for Pasquini's financing needs.
Correct Answer: Option A (Repo with $27,011,250) - The repurchase price is likely calculated using the face value of the bonds ($27 million) rather than the market value, which is common in repo transactions where the collateral's face value is used for pricing.
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Pasquini Investments (Pasquini) is a private brokerage looking for 30-day financing of $25 million of its accounts payable but is unsure whether the appropriate investment is a term repurchase agreement (repo) or a term reverse repo agreement. Pasquini is willing to post AAA-rated government bonds as collateral. The bonds have a face value of $27 million and a market value of $25 million. The firm is quoted a rate of 0.5% for the transaction. Which of the following choices most accurately reflects the contract type and the repurchase price needed by Pasquini?
A
Repo $27,011,250
B
Reverse Repo $25,010,417
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