CFA Mock 2011 Afternoon Q 50 Repo

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CFA Mock 2011 Afternoon Q 50
Kapoor is considering adding leverage to the portfolio by borrowing £55 million in a two-month repo agreement involving physical delivery of the portfolio’s holdings of AAA-rated U.K. sovereign bonds. The duration of this liability is 0.17 years. The proceeds of the repo agreement would be invested in additional U.K. corporate bonds and the resulting £310 million portfolio would have a duration of 5.82 years.
If the repo agreement is not entered into, Kapoor intends to reduce the portfolio’s duration to 4.00 years. She is considering using an interest rate futures contract. The futures contract is priced at £97,800 and the duration of the cheapest-to-deliver bond is 8.35 years. The conversion factor for the futures contract is 1.15.
Question: The characteristic of the repurchase agreement considered by Kapoor that would most likely increase the repo rate is the:
A. term.
A is correct because typically, the longer the maturity, the higher the rate. The very short end of the yield curve typically is upward sloping, leading to higher yields being required on longer- term repo
Can anyone please tell me if they see the link between the text, question and answer?
 
The duration of this liability is 0.17 years. The proceeds of the repo agreement would be invested in additional U.K. corporate bonds and the resulting £310 million portfolio would have a duration of 5.82 years. < - - - notice that when you enter a repo, your duration increases thus the term increases = > repo increases.
 
This is oht Bilal – overhead transmission
In this case, the repo is a liability. So any increase in repo rate would be on the wrong side imo. There may be something else going on here…
 
This question got me too. Remember, repos are extremely ultra-short term in nature. Their terms are generally overnight, a few days, etc…at most. Just by lengthening the term of the term a few days you could easily double or triple the length of the term which would have a dramatic impact on the overall rate.
 
Chuckrox8 wrote:
This question got me too. Remember, repos are extremely ultra-short term in nature. Their terms are generally overnight, a few days, etc…at most. Just by lengthening the term of the term a few days you could easily double or triple the length of the term which would have a dramatic impact on the overall rate.
Click to expand...
then, in this case, has rates increased because of two-month lending as opposed to overnight/daily repos? thanks in advance
 
Don’t overthink it. A repo rate is positively correlated with the term of the repo.
A 2-day repo rate is higher than a 1-day repo rate. Etc. That’s all the question is asking.
 
Factors influencing the repo rate:
  • Credit risk of borrower (+)
  • Quality of collateral (-)
  • Length of term (+)
  • Method of delivery (physical delivery lowers repo rate, no delivery increases it)
  • Scarcity of collateral (if collateral is scarce and the lender wants it, that will decrease repo rate)
  • Federal funds rate (+)
  • Seasonal Factors
 
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