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Explanation:
In a repurchase agreement, the borrower sells a security to the lender and agrees to repurchase it at a later date at a slightly higher price. This higher price effectively represents the interest on the loan. The 'repo margin' refers to the amount of collateral that the borrower is required to provide in order to secure the loan. If the value of the collateral drops below this required repo margin, it means that the collateral is no longer sufficient to cover the value of the loan. In such a scenario, the lender may require the borrower to post more collateral (i.e., to provide additional security for the loan) to bring the value of the collateral back up to the required repo margin. Alternatively, the lender may choose to 'reprice' the repo, which means that they will reduce the value of the loan to match the current value of the collateral. This reduces the lender's risk but also reduces the amount of money that the borrower will receive from the repo transaction.
Choice B is incorrect. The main benefit of repos to buyers is not that the repo rate is higher than borrowing from a bank. In fact, the repo rate is typically lower than the interest rate on an unsecured loan, which makes it a more attractive option for borrowers who need short-term financing.
Choice C is incorrect. Repurchase agreements are not long-term collateralized loans used by major financial institutions to obtain funding. They are typically short-term arrangements, often overnight, although they can be structured to last for longer periods.
Choice D is incorrect. If the value of the security rises, it does not necessarily mean that the buyer will be at a loss; and if the value decreases, it does not mean that the borrower stands neither to benefit nor be at a loss. The outcome depends on various factors such as whether or not there's a default and how much margin has been agreed upon in advance.
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Q.1870 Repos are increasingly trading in international money markets. Repos are usually loans exchanged against securities which are taken as collaterals to mitigate credit risk. However, some risk still remains: the seller may default by not repurchasing the securities at the due date. Therefore, the buyer can recover the amount lent by liquidating the securities. However, the securities may then have lost value due to market movements. In particular:
A
if the value of the collateral drops below the required repo margin, then the borrower may be asked to post the repo margin or the repo may be repriced in which the value of the loan is reduced.
B
the main benefit of repos to buyers is that the repo rate is higher than borrowing from a bank.
C
repurchase agreements are long-term collateralized loans used by major financial institutions to obtain funding.
D
if the value of the security rises, the buyer will be at a loss; if the value decreases, the borrower stands neither to benefit nor be at a loss.