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I'm having trouble understanding, conceptually, why the rate of return for buying a bond, shorting the future, and then delivering the bond into the future is called the "implied repo rate". I hear that it has to do with essentially being a synthetic reverse repo, but I can't understand exactly what the parallel is to repos.

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In a reverse repo transaction, one sells an asset and agrees to buy it back at an agreed upon price. This is in effect a securitized borrowing of money. The difference between the price the asset is sold, and the price that it is repurchased is the interest paid for borrowing the funds. The asset sold serves as the collateral or security for borrowing the funds. In the event the loan is not repaid, the lender has the asset and can sell it to recover the proceeds that is lent.

The lender is in a "repo" with the borrower, in that they bought the asset and agreed to sell it at an agreed upon price. This is similar to the "long basis" trade you describe, where one has bought a bond and short the future. The seller of the future has in essence agreed to sell the bond at the agreed upon "future" price. Hence, what you hear described as "synthetic reverse repo." The difference between these prices, less the interest earned from being long the bond, represents the interest the lender is earning from lending money to borrower and the rate is the "implied repo rate" that the short future is lending to the long future, as if they had entered into a repo trade.

With Treasury bond futures however, there are a number of bonds that can be delivered by the party that is short the future to the party that is long the future. For each of the bonds that are eligible to be delivered, the exchange determines a conversion factor where the future price is multiplied to make all the bonds equivalent to a 6% yield. As each of these bonds have different coupons and maturities, they will trade at different prices, and will have different "implied repo rates". The short future will naturally want to deliver the bond that is the "cheapest to deliver" (ctd bond). The ctd bond can change during the life of the contract depending on how interest rates move and the yield curve changes over the life of the contract. This optionality is referred to as the "switch option." This and other options that the long future has sold to the short future, in addition to interest rate moves, can impact the price of the future and "implied repo rate" over the life of the contract.

In a repo trade, a borrowing rate is agreed to and the price to rebuy is derived from this rate. In bond futures, the futures price is traded, and where the deliverable bonds are traded produces an "implied rate" on a loan.

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  • $\begingroup$ Thank you! It sounds like the reverse repo is “buying back at an agreed price” but repo is “selling at an agreed price”, so given that the long basis (short future) is selling at an agreed price, would it be more appropriate to classify it as a “synthetic repo”? I suppose it just depends on who is considered the counterparty in the transaction. $\endgroup$
    – rb612
    Feb 11 at 17:37
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    $\begingroup$ Reverse Repo and Repo are opposite sides of the same transaction. On Bloomberg's rate page, they quote it as bid-offer on Reverse Repo market rather than 2 different markets. The offer side is Repo and the Reverse Repo is the bid. Bid rate being higher than rate on the offer. One way to keep it clear is if the dealer is lending you money, (by buying your asset and selling it back to you to close the loan out), they will be charging you more interest than they will pay you if it is them that is borrowing from you. $\endgroup$
    – AlRacoon
    Feb 11 at 18:08
  • $\begingroup$ Got it, so just to make sure I'm following, given the bid rate is higher than the offer rate on the reverse repo, it's a reverse repo from the dealer's perspective. In other words, if it's 5% bid from a dealer on the reverse repo, the dealer is willing to buy the asset and agree to sell it back at a later date with 5% interest. So it's from the perspective of the dealer, not the retail investor. $\endgroup$
    – rb612
    Feb 11 at 18:48
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    $\begingroup$ That's correct. $\endgroup$
    – AlRacoon
    Feb 11 at 18:58
  • $\begingroup$ In this (outdated) copy of the Bloomberg BTMM screen you can see how the reverse repo is quoted (in the top right) with the bid rate higher than the ask investopedia.com/thmb/hk0BPwM9n8_yAZ3rY_tE7DLdlvU=/750x0/… $\endgroup$
    – nbbo2
    Feb 12 at 10:11

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