We are reviewing the underlying assumptions made by the Capital Asset Pricing Model (CAPM). Recall from last time the assumption that returns are distributed normally (i.e. a bell-shaped curve) and how this fails to account for skew and fat tails. Today we’ll look at CAPM’s assumption that there is but a single source of priced systematic risk: market beta.
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Prime brokers offer a variety of services to investors, from providing credit to clearing trades. One important service offered is known as Securities Lending. In Part One of this article, we’ll look at the contractual and collateral rules pertaining to Securities Lending.
As an investor or hedge fund, you may wish to borrow shares for a variety of reasons, such as shorting the stock or hedging a long position. An executed Securities Lending Agreement is the documentation required before shares are loaned. Continue reading “Securties Lending, Part One” »
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Repurchase agreements are contracts involving the simultaneous sale and future repurchase of an asset, most often Treasury securities. Typically, the seller buys back the asset at the same price at which it sold. On the buy-back date, the original seller pays the original buyer interest on the implicit loan created by the transaction. Interest due on a repo at maturity is at the rate for the stated maturity of the repo.
A reverse repo, or simple a reverse, is a contract in which a repo is structured so that a broker/dealer, a bank, or another party that normally uses the repo market to fund (finance) itself is cast in the role of securities purchaser and money lender Broker/dealers often cover shorts by reversing in securities.
A sell/buyback is essentially the same as a repo, except for the treatment of coupon interest. Coupon payments are not forwarded to the investor by the counterparty. Instead, the counterparty pays the investor repo interest on the coupon payment. When the sell/buyback terminates, the investor will receive its accrued coupon interest from the counterparty. A sell/buy back transaction also differs from a repo transaction in that the sales price for securities delivered differs from the purchase price paid when the securities are returned. The difference in the price of the sale and purchase transactions accounts for the amount of accrued coupon interest earned and the financing cost charged during the term of the loan.
A buy/sellback is similar to a reverse repo. Continue reading “Repurchase Agreements” »
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