How do firms you use repo trading to finance themselves and how exactly does this process work?
This was asked in an interview and I was unfamiliar with the process; nevertheless, I got a 2nd round interview and would like to be prepared for this question again.
Thanks
Surprising that anyone would ask you that in the first place for an SA interview, unless you're applying for a quant position in rates
You can synthesize a loan through trading spot and futures. Think about selling someone an asset, but simultaneously making an agreement to buy it back from them a year (or however long) later. You receive cash, but are obligated to pay out in a year. Say that asset trades for $100 today, and a futures contract for a year out specifies a price of $110. If you short the asset now and go long on the futures contract, you receive $100 now, and are obligated to pay $110 a year from now, effectively borrowing at 10%. The opposite is true as well, if you long the asset now and short a futures, you're lending money at 10% (assuming the asset has no storage costs, dividend yield, etc.)
Very little details, but that's the gist of it
Thanks for the response!
WTF to MvT's answer...why make it complicated and miss the gist of the question?
Here's the long and short of it: You're a bank. I need cash for liquidity purposes. I give you some high-quality securities I own (government bonds, AAA-rated covered bonds, etc...), and in return, you lend me 95% of their value and also charge me LIBOR +50 on the loaned money. In three months, I buy the securities back from you at face value. This also works from a reverse perspective.
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