REPO AND REVERSE REPO RATE

PRESENTED BY: CHAITHRA ASHOK

REPO RATE
Repo rate or repurchase rate is the rate at which banks borrow money from the central bank (read RBI for India) for short period by selling their securities (financial assets) to the central bank with an agreement to repurchase it at a future date at predetermined price. It is similar to borrowing money from a moneylender by selling him something, and later buying it back at a pre-fixed price. The Current repo rate is 8.5%.

Calculations Involved in Repo

Repo transaction involves two legs of calculation. The first is when cash and securities are borrowed and second is when they are returned at the end of the term. The settlement amount involves two components: Values of the transaction price. Accrued interest from the previous coupon date to the date on which transaction is initiated. Second leg involves: Repo interest for the term of repo Accrued interest from the previous coupon date to the end of repo term Return of principal amount borrowed.

Example:
Trade date : 20th July 2008 Trade price : Rs 1008.50 Face Value : Rs 10000000 (10000 bonds with a face value of Rs 1000 each) Security : 12.5% Last coupon date : 1st July 2008 Repo rate : 7.5% Repo term : 2 days

First Leg On 20th the seller of the repo receives the following sum Value of security : 1008.50*10000 = 10085000 Accrued interest : 12.5* 10000000*19/360*100 = 65972.22 Settlement amount : 10085000+ 65972.22= 10150972.22

Second Leg: On 22nd July the seller returns the amount Original Borrowing : Rs 10085000 Accrued interest : 12.5* 10000000*21/360*100= 72916.66 Repo Interest : 7.5* 10000000*2/360*100=4166.66 Amount to be returned = 72916.66+4166.66= 10096111.1

REVERSE REPO
Reverse repo rate is the rate of interest at which the central bank borrows funds from other banks for a short duration. The banks deposit their short term excess funds with the central bank and earn interest on it. Reverse Repo Rate is used by the central bank to absorb liquidity from the economy. When it feels that there is too much money floating in the market, it increases the reverse repo rate, meaning that the central bank will pay a higher rate of interest to the banks for depositing money with it. Current Reverse repo rate is 6.5%.

IMPACT OF REPO AND REVERSE REPO RATE

Loans like home loan, car loan are been costlier Contraction of industrial output