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I am trying to understand how repos work.

It is my understanding that selling equities with the promise of buying them back at later time is called repo (short for Repurchase agreement). If one sells a bond on repo and then the bond pays its periodic payment while other party owns it, who gets the payment, repo issuer or repo buyer?

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The Wikipedia page for Repurchase Agreement has two relevant pointers on this topic:

  1. The legal title for any securities used in a repo actually pass from seller to buyer during the term of the agreement. In basic terms this means that if one sells a bond on repo with a promise to buy it back, then the ownership actually transfers to the buyer for that period of time.

  2. If a coupon is paid during this time period, it can either go to the buyer or the seller. Usually, the coupon payment goes to the initial owner of the security pre-repo (our "seller"). But sometimes the repurchase agreement will specify otherwise. So, again in basic terms, usually the repo seller/initial security owner receives any payments made during the term of the repurchase agreement.

(Both points are in the first paragraph of the section "Structure and Terminology".)

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  • The Seller in this case is the original owner NOT the borrower of the security. From Wikipedia: Coupons (interest payable to the owner of the securities) falling due while the repo buyer owns the securities are, in fact, usually passed directly onto the repo seller.
    – dcaswell
    Commented Sep 18, 2013 at 5:29
  • thanks, @user814064. I updated it to be correct based on what you pointed out.
    – THEAO
    Commented Sep 18, 2013 at 9:45
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Repurchase agreements are a way of financing a security position. You have a collateralized loan where you give your security in exchange for cash.

Let's say you have a 10 year Treasury note paying 3.5% while the 1-week repurchase rate is 0.5%. You loan the security to someone with a promise to repurchase it from them some time in the future. You collect the 3.5% coupon and you pay the 0.5% interest.

Clearly it makes no sense for someone to collect interest on money and also collect coupon payments. And for the counter-party it makes no sense to be not getting coupon payments and also to be paying interest.

This how one website explains the process:

During the transaction, any coupon payments that come due belong to the legal owner, the "borrower." However, when this happens, a cash amount equal to the coupon is paid to the original owner, this is called "manufactured payment." In order to avoid the tax payment on the coupon, some institutions will repo the security to a tax exempt entity and receive the manufactured payment and avoid the tax ("coupon washing")

I find this unequivocal description to be the clearest

During the life of the transaction the market risk and the credit risk of the collateral remain with the seller. (Because he has agreed to repurchase the asset for an agreed sum of money at maturity). Provided the trade is correctly documented if the collateral has a coupon payment during the life of the repo the buyer is obliged to pay this to the seller.

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  • Since it says Provided the trade is correctly documented I think answer to my question might depend on the agreement.
    – yasar
    Commented Sep 18, 2013 at 7:10
  • @yasar11732 The reason that the Repo Market exists is so you can finance the security positions you own. If you're not collecting accrued interest, or coupon payments you might as well sell the security outright. And from the other side of the transaction people don't loan money because they wish to own the asset in question, they do it to collect interest on cash that is not being used over a short period of time.
    – dcaswell
    Commented Sep 18, 2013 at 12:37

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