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REPO

A REPURCHASE AGREEMENT (REPO) is an agreement whereby a bank sells a broker/dealer a money market instrument, usually a T-bill, with the agreement to buy it back in a certain period of time for a specific (higher) price. Repurchase agreements are generally issued for overnight or up to 10 days, though some are issued for longer durations. There is no maximum duration for repurchase agreements.

The main players in repurchase agreements are: Broker/dealers make arrangements between buyers and sellers

Corporations either have money or need to borrow money

Banks may need money overnight to meet their reserve requirement, or,conversely, may have extra cash

The Fed probably the biggest player since it controls anenormous amount of cash invested for short-term investing The overnight repurchase agreements that are traded between banks are especially good because they: Have no interest-rate risk Have no market risk Pay interest equal to the Fed funds rate

Featured Article

Share Repurchase Agreement and Stock Buy Back Explained
By David Michael L

To those who are familiar with stock dividends or stock splits, a share repurchase agreement is like the opposite. In this case, the company does not give out extra free shares of stock to stockholders (which will become "outstanding" in the market).

Instead, the company buys back stock certificates from some stockholders (not all), so the company instead ends up with less of these in the market being owned by the remaining stockholders. (These are then deposited in the company's treasury, and are not considered part of the "outstanding" certificates).

You may think that this means that each of the certificates should now each have higher value because there will now be less outstanding certificates representing the full value of the company.

Actually, in theory, the answer is "no". Why? Because we assume that when the company buys back these certificates, it pays out its own cash. So now, the overall company is worth less because it has less cash. So yes, each outstanding certificate may now own a bigger percentage of the company, but the company itself is now worth less than before. However, this assumes that the company buys back its own certificates based on the fair value of the company. (In real life, the company will probably buy these back at an amount closer to the market price, which rarely reflects the "fair" value.)

How about earnings? Yes, there will now be fewer shares of stock to take part in the company's earnings. Therefore, each certificate should be earning more than before (increased earnings per share). Shouldn't this increase the value and price?

Again, the answer is "no" for 2 reasons:

1) The company is now in a riskier position because it has less cash. This increased risk makes the company less valuable. Therefore, the increased risk should offset the benefit of increased earnings... which should theoretically keep the certificate's market price the same.

2) This increased earnings per share will only benefit the stockholders if it is paid to the stockholders in the form of cash dividends. However, as suggested in another article by this same author, paying cash dividends will decrease the value of the certificate by the same amount as the dividend payout; so it will have no benefit in the end. So since there's no extra benefit from the increased earnings per share and increased dividends, this should have no impact on the price of the certificate. Moreover, the net present value of your extra future dividends may just be offset by the cash the company loses (which you are entitled to because of your part-ownership of the company) in order to buy back its own certificates.

As can clearly be seen, a share repurchase or stock buy back does not necessarily benefit stockholders.

Again, this is all just in theory and assumes the shares of stock are bought back at their "fair value". In real life, the stock's market price doesn't always follow the fair value or "appropriate" price, so the company won't be able to buy these back at the fair value.

David Michael is the creator of MBAbullshit.com, a fun and free online tutorial website for lots of MBA courses and business school topics. Go to http://mbabullshit.com/blog/2011/12/22/dividend-policy-and-share-repurchase-in-11-minutes/ and watch a super easy video Dividend Policy,Share Repurchase and Stock Buy Back in 11 minutes.

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