\nshort-term repos is the inventory of stocks available to
\nbe lent. When borrowing demand is high and inventory
\n(available for borrowing) is low, repo fees will tend to rise.
\nHigh borrowing demand can be due to a number of reasons,
\nsuch as:<\/p>\n
Strong negative outlook on equities means that speculators
\nwant to sell the stocks to benefit from the stock going
\ndown \u2013 but of course they need to borrow it to ensure they
\ncan deliver it.<\/p>\n
Corporate actions<\/strong> \u2013 can lead in some cases to a possible However, there are other costs that can be incorporated Withholding tax<\/strong> \u2013 as seen a key element to forward Balance sheet costs<\/strong> \u2013 for a seller of an equity index TRS Frictional costs<\/strong> \u2013 a catch all for items such as brokerage a. Relation between equity index TRS spread In determination of the forward price the repo rate In respect of the equity index TRS the spread is the rate over Hence TRS spread is (to a greater part) the inverse of b. Negative repo rates<\/strong><\/p>\n In theory, with all things being equal, negative repo rates A sustained negative repo rate implies that, instead of This has in fact been the case since 2013. The key driver The key impact of this directive is to restrict the traditional In terms of EURO STOXX 50\u00ae (SX5E) forward pricing The \u201cother\u201d factors in the determinant of forward prices a. Calculation of implied repo<\/strong><\/p>\n The shorter end of the implied repo curve is determined We can therefore determine that of the 11.22 index points b. Impact of implied repo<\/strong><\/p>\n The impact of negative implied repo rates has a knock on Short forward exposure brings two additional risk elements. Typically the forward exposure is hedged using a combination Index total return futures represent the final piece in terms A buyer of an index total return future, as with a TRS, a. Payout profile of an index total return futures Index TRFs are structured to replicate the net payout profile For the EURO STOXX 50\u00ae Index (SX5E \u2013 a price return In respect of the financing costs this will be made up of For the TRFs the benchmark rate will be used to calculate The remaining spread amount will be determined or b. Pricing a total return future (TRF)<\/strong><\/p>\n Theoretically in order to pay the total returns to the buyer, The financing costs consists of the benchmark interest rate In respect of an index total return future the cost related Therefore the outstanding element to be priced is Therefore a seller would charge an additional spread to
\narbitrage and arbitrageurs would want to benefit from it
\nwithout taking exposure on the stock, hence they would
\nbuy the stock and sell a forward, again putting pressure
\non the repo rate.<\/p>\n
\ninto the traded spread such as:<\/p>\n
\npricing is distributions applied during the reference period.
\nIn the case of dividends however these are generally
\nsubject to a domestic withholding tax and hence allowances
\nmay be made for this.<\/p>\n
\nthe immediate hedge could be to buy the cash basket
\nin order to replicate the returns \u2013 which may have balance
\nsheet costs that would be passed on through inclusion
\nin the spread.<\/p>\n
\ncommissions which impact cash basket replication etc.<\/p>\n
\nand repo rate<\/strong><\/p>\n
\nis subtracted from the interest rate to determine the total
\nfinancing cost i.e. this amount is the assumed income
\na holder of the cash index will earn in the repo market.<\/p>\n
\nthe reference interest rate that a buyer (receiver) of total
\nreturns must pay to the seller (payer) and of which repo rate
\nis the key driver. If the holder of a cash basket can receive
\nincome from repo of the underlying stocks then equally
\nthe buyer (receiver) of an equity index TRS would expect
\nthe spread to be subtracted from the financing cost.<\/p>\n
\nthe repo rate.<\/p>\n
\nshould be arbitraged away by a simple trade of selling the
\nforwards\/futures and buying the cash basket at the current
\nfunding rate. The trader can then make risk free profit
\nbetween the actual repo amount earned and the negative
\nrepo rate implied from the forward price (assuming
\nthe minimum earnable is zero \u2013 but that still implies a profit).<\/p>\n
\nearning repo from the cash securities held, the dealer is
\nin fact \u201cpaying\u201d an amount to remove the securities
\nfrom their balance sheet.<\/p>\n
\nis the balance sheet constraints currently applicable to banks
\nunder the Basel III reforms introduced by the Bank of International
\nSettlements (BIS) and its implementation in Europe
\nunder the Capital Requirements Directive IV (CRD IV).<\/p>\n
\nfinancing activities of banks Delta 1 desks as the cost
\nof capital applied to balance sheet use (such as holding cash
\nequities) has made these trades unprofitable. Thus since
\n2013 negative repo rates have been sustained and equally
\nequity index TRS spreads have stayed positive.<\/p>\n2. Implied repo<\/h2>\n
\nthe majority of inputs are directly observable. In particular
\nindex spot rate and interest rates are directly observable
\nand distributions such as gross dividends are either directly
\nobservable, or if projected, can be hedged with for example
\nthe EURO STOXX 50\u00ae Index Dividend Futures.<\/p>\n
\n(predominately the repo rate) are usually implied for market
\nprices and are aggregated under the term of \u201cimplied repo\u201d.<\/p>\n
\nusing liquid index futures such as the Futures on the EURO
\nSTOXX 50\u00ae Index.<\/p>\n![\"example_4_-_calculation_of_implied_repo.jpg\"](\"http:\/\/www.next-finance.net\/http:\/\/beta.next-finance.net\/wp-content\/uploads\/2017\/01\/example_4_-_calculation_of_implied_repo.jpg\")
<\/a><\/p>\n
\nof basis (cash index \u2013 futures price) of the Dec 16 contract,
\n1.25 index points is due to the implied repo \u2013 the rest being
\na function of dividends and the interest rate funding.<\/p>\n
\neffect to structured trading and exotic desks \u2013 particularly
\nin Europe. These desks in effect sell quantities structured
\nretail products such as autocallables[[Autocallable is a feature of an exotic option that is often found in structured products with longer maturities.
\nA product with an autocallable feature would be called prior to maturity if the reference index is a predetermined
\nindex level on specified observation dates. The investor would receive the principal amount of their investment
\nplus a pre-determined premium (or a coupon) and the product terminates.]] through which they are
\nselling downside risk. These desks are therefore typically
\nshort forward exposure.<\/p>\n
\nThe dealer will be long dividend exposure (a fall in dividends
\n= a rise in forward prices) and long repo exposure (a fall
\nin repo = a rise in the overall financing costs = a rise in
\nforward prices). Whilst dividend risk can be hedged effectively
\non the SX5E using EURO STOXX 50\u00ae Index Dividend Futures,
\nthe negative implied repo represents a cost to trading.<\/p>\n
\nof standard index futures and synthetics (call minus put at
\nsame strikes in longer dated options), or by using total return
\nswaps (TRS).<\/p>\n3. Index total return futures \u2013 Implied repo<\/h2>\n
\nof hedging forward exposure by allowing trades to be based
\non implied repo rates.<\/p>\n
\nreceives the total returns of the reference index, the equity
\namount i.e. both capital and distributions. Against this
\nthe buyer pays the financing costs in the form of a funding
\nrate plus or minus a spread. The TRF futures unlike
\nconventional futures are priced in terms of the spread
\nin basis points.<\/p>\n
\n(TRFs)<\/strong><\/p>\n
\nof the index total returns. In terms of equity amounts
\nthe buyer would receive the gross total returns relating to
\nthe reference index.<\/p>\n
\nindex) for example, a buyer would receive the total returns
\nfrom the SX5E plus any distributions attributable. In the case
\nof the EURO STOXX 50\u00ae an additional EURO STOXX 50\u00ae
\nDistributions Point Index (SX5EDD) is calculated and
\nthe equity amount of the total returns is the sum of these
\ntwo indexes.<\/p>\n
\nthe funding cost attributable to the benchmark funding rate \u2013
\nwhich for the EUR-denominated SX5E will be EONIA \u2013
\nand the additional spread agreed at the inception of the trade.<\/p>\n
\nthe funding charge for the index and will be netted with
\nthe equity amount (i.e. for the buyer will be subtracted from
\nthe equity amounts \u2013 representing an underperformance
\ndue to these costs[[The term \u201ccosts\u201d in this instance is based on a premise of positive interest rates \u2013
\nin a negative interest rate environment this will be inverted and will be positive
\nin terms of performance.]]).<\/p>\n
\ntraded by agreement between the two parties. This will be
\npriced in basis points on an annualized basis and represents
\nthe additional cost (if spread is positive) to be paid by
\nthe buyer to the seller of equity index returns until maturity.<\/p>\n<\/a><\/p>\n
\nthe seller would purchase the cash basket and would have
\nto pay the financing costs to maturity \u2013 these charges they
\nwould naturally pass on to the buyer.<\/p>\n
\nfunding charge (i.e. the borrowing cost for the cash used
\nto purchase the cash basket) less any (positive) implied repo
\nthat can be achieved (all other costs are disregarded).<\/p>\n
\nto the benchmark funding rate (EONIA\u00ae in the case of
\nSX5E) is incorporated into the daily returns calculation as
\nan underperformance of the equity amount based on
\nthe funding amount due.<\/p>\n<\/a><\/p>\n
\nthe (implied) repo amount for that index until expiry.
\nA negative repo rate means that financing costs will
\nbe greater than the benchmark funding rate as it represents
\nan additional cost and hence the seller would expect the buyer to compensate them for this additional amount.
\nTherefore negative implied repo (which represents
\nan additional cost to the holder of long equity) = positive
\nTRF spread.<\/p>\n
\nthe buyer and this is reflected in index total return futures
\non the EURO STOXX 50\u00ae at Eurex which, in common
\nwith market convention, is priced in basis points (one basis
\npoint = 0.0001 or 0.01%).<\/p>\n