Question

Assume that you work for one of the largest investment banks in Turkey and as a securities dealer you sell a corporation some Treasury bills at a price of TL9,856,873 while simultaneously agreeing to repurchase these Treasury bills in 7 days for a price of TL9,883,563.

a. Explain who the borrower and lender of money are in this transaction.

b. Calculate the annualized rate of return for this transaction.

c. If the current implied repo rate for a cash-and-carry transaction is 15 percent, explain who would have an arbitrage opportunity (you or the corporation?). Briefly describe the transactions for taking advantage of this arbitrage opportunity.

Answer 1

a.

Also known as a repurchase agreement and product financing arrangement, this type of transaction occurs between two parties. The first party "sells" their inventory to the second party, with an explicit promise to buy back the inventory at a predetermined price over time, or at a future point in time.

The benefits of such agreements include:

• Buyer: the party purchasing the inventory is able to use this asset as collateral, obtaining a loan to repay the seller for the merchandise. As the seller repurchases the inventory, the money received from the seller is used to repay the loan.
• Seller: by transferring inventory to the buyer, the seller is able to finance its inventory even though it's legally owned by the buyer. By entering into this type of arrangement, it may be able to avoid paying certain property taxes on goods held in inventory. The balance sheet of the seller also remains clear of the inventory and the associated liability.

Here , Security Dealer is Lender and the corporation who is purchasing investment is Borrower.

b. Annualized Return = [(9883563-9856873)/ 9883563] * 365/7

= 14.12%