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Repurchase agreements (repos) are extensively used in dealer financing, customer funding, and matched book trading. The repo desk has become the hub around which revolve the trading, hedging, and arbitrage strategies.  At many firms the repo desk has become a key profit center. Repo market can be used to understand the relative values between bonds and to access the valuation of futures contracts.

The repo market is the biggest money market. In a typical repo transaction, a dealer puts u liquid securities as collateral against a cash loan while agreeing to repurchase the securities at a future date.  The start-leg is usually settled the same day.  The close-leg, repurchase is a forward transaction.  The repo markets are often called financing markets.

Repo rates depend on the collateral used. The higher the credit quality and the easier the security is to clear, the lower the repo rate. Treasury repos trade at lower levels than federal agency repos, which trade at lower levels than mortgage backeds.  The second factor is for maturities between one day and one year. Most of the repo transactons have maturities of three months or less.  One-day transactions are called overnight repos; longer maturieis are called term repos. An open repo is an overnight repo that rolls automatically until terminated by either party.

Both parties to a repo transaction are exposed to credit risk, due to changes in the market value of the collateral. The cash lender ususally receives a margin or haircut, in which the mark-to-market value of the securities ut up as the collaterl is more than the loan value.

The problem we have in the current economy is that Treasury rates are super low. When rates tumble to low levels, it reduces the economic incentive to lend securities. The reduction in liquidity in the $5,800billion Treasury market comes at a time when conditions have become strained.  Low rates are having a corrosive effect on the repo market which will impair liquidity in Treasuries.  The zero % interest rate environment is effectively eliminating the dealer matched-book business and damaging the repo market.

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