Pinebank Capital enters a repurchase agreement under which it sells Treasury securities to Ironhill Clearing and agrees to buy them back at a set price on a stated date. A coupon is paid on the securities during the term. Which statement describes the substance of the arrangement?
- A.Pinebank has effectively lent cash and keeps the coupon, because the party delivering securities is the lender.Wrong. The side delivering securities is the side taking in cash, which makes it the borrower.
- B.Pinebank has effectively borrowed cash against the securities and retains the economic benefit of the coupon.Correct. It took in the cash and never gave up the economics of the position, so both the borrowing and the income belong to it.
- C.Ironhill has effectively borrowed cash and keeps the coupon, because title passed to it at the opening leg.Wrong. It supplied the cash, and passing title is a collateral mechanic rather than a transfer of economics.
- D.Neither firm has borrowed; the legs are independent sales and the coupon follows the record holder on the payment date.Wrong. An agreed repurchase price and date is exactly what makes the two legs one financing rather than two sales.
Why: A repurchase agreement is documented as a sale with an agreement to repurchase, but it functions as a secured borrowing. The party delivering the securities and receiving cash at the opening leg is the borrower; the party delivering cash and taking the securities as collateral is the lender, and from that side the same trade is a reverse repurchase, or resale, agreement. Because the borrower has not given up the economics of the position, coupon income paid during the term is passed back to it rather than kept by the cash lender. Were the parties intending a true outright sale, there would be no agreed repurchase price and date, and the coupon would simply follow ownership.