Question

How does a portfolio manager use repurchase agreements or reverse repurchase agreements to increase the duration of the portfolio? What is the duration if the portfolio manager purchases a bond with a duration of 5 and finances the purchase with a repo with a haircut of 4%?

Answer 1

Repurchase agreements are generally considered safe investments because the security in question functions as collateral, which is why most agreements involve U.S. Treasury bonds. Classified as a money-market instrument, a repurchase agreement functions in effect as a short-term, collateral-backed, interest-bearing loan. The buyer acts as a short-term lender, while the seller acts as a short-term borrower. The securities being sold are the collateral. Thus the goals of both parties, secured funding and liquidity, are met.