With the cessation of LIBOR imminent, CME RepoFunds Rate (RFR) futures can unlock trading and risk management opportunities in the previously opaque repo market. These products allow market participants to hedge repo trades more effectively by providing instruments that are highly correlated with European repo rates.

What is a Repo?

A repurchase agreement, often referred to as “repo,” is a secured short-term (usually overnight) loan using government or other securities as collateral. The borrower provides the government security to the lender for collateral and then receives it or a like security back at the end of the agreed loan or repo term. The annualized rate between the initial sale and the subsequent re-purchase price is known as the “repo rate.” Given that repo transactions are usually short-term and collateralized by high-quality government bonds, the repo rate is generally thought to represent the cost of the safest form of borrowing. 

Cash-and-Carry Arbitrage

In a cash-and-carry strategy, a trader enters two offsetting positions in the same underlying asset exposure: (a) a long position in the cash market, and (b) a short position in the futures market. The trader then delivers (carries) the underlying security at the expiration of the futures contract. The return of this transaction is calculated as the difference between the price of the futures price less the cash market price; the rate of return on this difference is the implied repo rate.

CME Group RFR futures can help in trading the cash-futures basis trades between a repo transaction and the future.

Given that the initial purchase of the security in the cash market (the long position) is often made with borrowed funds, the trade is pure arbitrage (completely risk free) when the implied repo rate is greater than the cost of borrowing.

There are thus five main components of a cash-and-carry strategy:

C = Cash market price

F = Futures invoice price  

I = Implied repo rate

R = Borrowing cost

Actual = days remaining in interest period

The implied repo rate (I) is thus calculated as: 

I = ( (F / C1 ) * (360 / Actual) )

A profitable trade occurs when the short side cost, which includes the cost of the acquiring and financing the security, is less than the received futures price. This can be expressed as:

Inputting notional figures demonstrates why this is the case. Imagine a scenario where a dividend-free security is priced at €70 in the cash market and €70.50 in the futures market. Borrowing costs are 1.25% and the futures contract expires in 91 days. 

In this case, the trader would purchase the security in the cash market with borrowed money and deliver it for €70.50 at the expiration of the contract 91 days in the future. The full cost of the cash market transaction is:

The trade would thus yield a profit of:

€70.50 - €70.22 = €0.28

The implied repo rate for the transaction would be:

I = ( (70.50 / 70) - 1 ) * (360 / 91) ) = 1.57%

Note that if the total cost of borrowing exceeded the already-determined price of the futures contract delivery price, then the trader would incur a loss.

Notional Cash-and-Carry Example

Time

Action

Cash Flow

Comments

Day 0

Short futures contract

0

Will be delivered 91 days forward at agreed-upon price of €70.5

Buy in cash market 

-€70

Occurs with immediate effect

Day 1 to 91

Pay borrowing costs

-€0.22

Borrowing costs may be variable and occur over time

Day 91

Complete futures purchase

+€70.5

Occurs with immediate effect

Net cash flow

+€0.28

 

Real-World Example and CME RFR Futures Hedging

Now that we have established the basic concepts involved in the cash-and-carry strategy, let us move toward a real-world example with a related but slightly different trade: a reverse cash-and-carry strategy in the German bond market. 

In a reverse cash-and-carry strategy, instead of buying the underlying in the cash market and shorting the futures contract, the trader shorts the security by selling it in the cash market and concurrently goes long the futures contract. The trader then lends the cash proceeds from the sale of the security into the repo market each day with that same security used as collateral on the transaction. Upon the expiration of the futures contract, the trader closes the short security position after taking delivery of the security. 

Functionally, this switches the trader from cash borrower to cash lender:  

  • Cash-and-Carry Strategy: This is profitable when the total cost (including borrowing costs) of buying a cash market security is less than the futures price of the same security. 
  • Reverse Cash-and-Carry Strategy: This is profitable when the total cost of selling and repo-ing the proceeds of a cash market security is greater than the futures price of the same security.

Repo rates are thus critical to the P&L of traders employing one of these strategies.

German Bund Trading

Let us imagine a trader looking to take a reverse cash-and-carry position in the German Bund market in late 2022. This entails using Euro Bund futures as the futures contract with the below contract specifications – note that this futures contract requires the short position to deliver an underlying security in accordance with the “deliverable grade” standards below at the expiration of the contract. While there are technically several bonds that are eligible for delivery, short positions will seek to deliver the “cheapest-to-deliver” (CTD) bond. The CTD is the security that the trader employing a reverse cash-and-carry strategy will receive at expiration and thus the security that will be shorted in the cash market. 

Eurex Euro Bund Futures Contract Specifications

Minimum Pricing Increment

€ 10

Deliverable Grade

8.5 - 10.5 years remaining

Original term <= 11 Years

Min Issue Size: €4B

Coupon

6%

Notional

€ 100,000

Listing Schedule

Three nearest quarterlies (March, June, September, and December)

Delivery Date

Tenth day of delivery month (if not a business day, next valid business day)

Notification Deadline

Last Trading Date

Last Trading Date

T-2 Business days from delivery date


The trader identifies a 0% coupon German Bund maturing on 15 Aug 2031 as the CTD security for the Dec 22 Euro Bund future with a delivery date for the underlying security of 12 Dec 2022. The trader immediately sells €100 million notional of this bond at a price of €84.702 – realizing €84,702,000 on 17 Nov 2022. These proceeds are immediately lent out in the repo market against this bond as collateral. Note that the 0% coupon means there are no coupon payments made to the bond holder.

The trader also immediately purchases 1000 Dec 2022 Euro Bund futures contracts at a price of €140.21 per contract on 17 Nov 2022. This price is multiplied by the Euro Bund futures conversion factor of 0.60325, resulting in a delivery price for this contract of €84,581,680, which will occur 24 days forward on 12 Dec 2022.

What is a Conversion Factor?

A conversion factor is the approximate decimal price at which a security would trade if it had a 6% yield-to-maturity. They are used for bond futures contracts that require the physical delivery of the underlying security at expiration. Given that there are often many different securities eligible to be delivered at the expiration of a certain contract, traders will seek to identify the cheapest-to-deliver bond to fulfil the delivery requirements. Employing a conversion factor standardizes the price of all bonds eligible to be delivered into a given futures contract and enables the identification of the cheapest-to-deliver security.

We thus have three of four pieces of our P&L calculation as we know that there are 24 days between 18 Nov 2022 and 12 Dec 2022. The only remaining variable is the financing rate that the trader will receive on the repo-ed proceeds:

Again, the repo rate is a key component here and is a main driver of a profitable trade. CME Group’s Germany RepoFunds Rate helps traders understand and hedge movements in repo rates over a given period. Below are the accumulated and to-be-accumulated Germany RepoFund Rates for the Dec 22 Germany RFR futures contract. This contract provides a compounded average repo rate for a three-month period using actual German repo market transactions and creates a futures price using the 100 – rate methodology common in other short-term interest rate futures products. 

At this point in time (as of 17 Nov 2022), the trader knows that: 

  • There is a 24-day period from 18 Nov 2022 to 12 Dec 2022 where both the bond future and Germany RFR future will be active
  • There is an additional nine-day period from 13 Dec 2022 to 21 Dec 2022 where the bond future has expired and only the Germany RFR Future will be active
  • The Germany RFR future thus has a total active period of 33 days from the opening of the position to the contract’s settlement1

We will use this data to walk through two potential scenarios that could occur ahead of our delivery date of 12 Dec 2022 for our reverse cash-and-carry example.

Scenario #1: The Market Continues On

In this scenario, we will assume that there are no major changes in the repo market –the final 24 days of the trade go as market expectations dictate. In this case, we can calculate the annualized repo rate by first determine the compounded daily interest accumulation factor (DIAF) for realized days in the Germany RFR futures contract: 

DIAF = Product [all realized DIAF figures for period] = 1.000833%

To determine what the implied remaining rate is, use the Germany RFR futures price of €99.210 and a total accumulation of 91 days in the contract:

Rate implied by RFR Futures Price:  ( (100-99.210)/100) * (91/360) ) + 1 = 1.001997%

Dividing the implied rate by the compounded DIAF gives the remaining rate expectation:

Finally, annualize this rate based on the 33 remaining unrealized days in the contract accumulation period:

This final figure can be used to determine R and estimate the total P&L of the trade, assuming that the annualized repo rate for the 24-day period of the futures contract is the same as it is for the 33-day period of the RFR contract:

Total P&L is thus positive:

P&L = (€84,702,000 + €71,651.54) - €84,581,680 = €191,971.54

Real World Reverse Cash-and-Carry (Scenario #1)

Time

Action

Cash Flow

Comments

Day 0

Long Bond futures contract

0

Will be purchased 24 days forward at agreed-upon price of €84,581,680

Short sell bonds in cash market

+€84,702,000

Occurs with immediate effect

Day 1 to 24

Invest short-sell proceeds in repo market on daily basis

+€71,651.54

Repo rates may be variable and occur over time

Day 24

Complete futures purchase

-€84,581,680

Occurs with immediate effect

Net cash flow

+€191,971.54

 

Scenario #2: Market Disruption

In this scenario, we will assume that major disruptions in the repo market rapidly and unexpectedly lower repo rates, and that this change is reflected the price of Dec 22 German RFR futures moving to a price of €100.50 immediately after the reverse cash-and-carry trade is initiated. Using the same data set as above demonstrates how this affects P&L.

The compounded daily interest accumulation factor (DIAF) for realized days in the Germany RFR futures contract remains the same:

DIAF = Product [all realized DIAF figures for period] = 1.000833%

To determine what the implied remaining rate is, use the new Germany RFR futures price of €100 and a total accumulation of 91 days in the contract:

Rate implied by RFR Futures Price:  ( (100 - 100.50) / 100) * (91 / 360) + 1) ) = 0.9987%

Dividing the implied rate by the compounded DIAF gives the remaining rate expectation:

Finally, annualize this rate based on the 33 remaining unrealized days in the contract accumulation period:

This final figure can be used to determine Repo Interest Income and estimate the total P&L of the trade, assuming that the annualized repo rate for the 24-day period of the futures contract is the same as it is for the 33-day period of the RFR contract:

Total P&L is thus negative:

P&L = (€84,702,000 + -€129,053.38) - €84,581,680 = -€8,733.38

Real World Reverse Cash-and-Carry (Scenario #2, No Hedge)

Time

Action

Cash Flow

Comments

Day 0

Long Bond futures contract

0

Will be purchased 24 days forward at agreed-upon price of €84,581,680

Short sell bonds in cash market

+€84,702,000

Occurs with immediate effect

Day 1 to 24

Invest short-sell proceeds in repo market on daily basis

-€129,053.38

Repo rates may be variable and occur over time

Day 24

Complete futures purchase

-€84,581,680

Occurs with immediate effect

Net cash flow

-€8,733.38

 

Hedging with CME Group’s Germany RepoFunds Rate Futures

Imagine that prior to initiating the reverse cash-and-carry trade, that the trader covered downside risk by hedging the position with CME Group’s Germany RepoFunds Rate futures. In Scenario #2, used above, this would entail entering a long position in Germany RFR futures at a price of €99.210 prior to the price of this contract moving to €100.50. 

To determine how many contracts we should use to hedge, we must understand two data points: first, that the notional value we are trying to hedge against is the cash value of the transaction (€84,702,000); and second, that the bond future expires 24 days forward and the German RFR future 33 days forward. Again, we assume that the rates between the 24-day period and 33-day period will remain constant. This gives us the proportional cash value of our short sale:

We then divide this figure by the German RFR futures notional index value to arrive at our number of contracts:

62 contracts with a value of €25 per basis point change results in a value of: 

P&L from hedge = (100.50 - 99.210) * €25 * 62 contracts = €199,950

Real World Reverse Cash-and-Carry (Scenario #2, With Hedge)

Time

Action

Cash Flow

Comments

Day 0

Long Bond futures contract

0

Will be purchased 24 days forward at agreed-upon price of €84,581,680

Short sell bonds in cash market

+€84,702,000

Occurs with immediate effect

Long German RFR futures

0

Will be purchased 24 days forward at agreed-upon price of €99.210

Day 1 to 24

Invest short-sell proceeds in repo market on daily basis

-€8,733.38

Repo rates may be variable and occur over time

Day 24

Receive delivery of bond from futures contract

-€84,581,680

Occurs with immediate effect

Complete German RFR futures purchase

+€199,950

Movement of RFR price to €100.5 results in 129 bps net profit per contract

Net cash flow

+€191,216.62

 


This hedge would cover all the loss from the un-hedged trade in Scenario #2 above and yield a net profit of €191,216.62, which is nearly identical from the total trade P&L in Scenario #1 of €191,971.54:

Total P&L from Trade = €199,950 - €8,733.38 = €191,216.62

Limitations and Remaining Risks

This example demonstrates how CME Group RepoFunds Rate futures can help hedge exposure to repo rates during a basis trade. However, it should be noted that unhedged risks remain in this example.  

Recall that the trader is repeatedly borrowing via the repo market in exchange for cash and the security used in the initial cash market short sale. Borrowing a specific security in the repo market exposes the borrower to specialness risk. Specialness occurs when a particular security becomes in high demand and its financing rate falls to less than that of general collateral. Specialness can significantly decrease the financing rate of a particular security, often into negative territory. 

While Scenario #2 above deals with negative repo rates, these rates generally reflect the financing rate for the repo market’s general collateral pool and only a portion of the special collateral pool as the benchmark administrator employs a filtering mechanism for special collateral2. This means that a situation could occur where general collateral repo rates (and thus RRF benchmark rates) remain relatively high while the trader is uniquely exposed to low specialness financing rates in a particular security.


1 Consult Appendix A for a full overview of referenced dates and corresponding realized repo values
2 Consult this link for full details on the RepoFunds Rate methodology: https://www.cmegroup.com/market-data/cme-group-benchmark-administration/files/repofunds-rate-benchmark-methodology.pdf


Appendix A: CME Group Germany RFR Data

Date

RFR Germany

DIAF

Days

9/21/2022

0.166

1.000005

1

9/22/2022

0.201

1.000006

1

9/23/2022

0.251

1.000021

3

9/26/2022

0.25

1.000007

1

9/27/2022

0.28

1.000008

1

9/28/2022

0.296

1.000008

1

9/29/2022

0.317

1.000009

1

9/30/2022

-0.463

0.999961

3

10/3/2022

0.297

1.000008

1

10/4/2022

0.321

1.000009

1

10/5/2022

0.322

1.000009

1

10/6/2022

0.309

1.000009

1

10/7/2022

0.318

1.000027

3

10/10/2022

0.325

1.000009

1

10/11/2022

0.331

1.000009

1

10/12/2022

0.369

1.000010

1

10/13/2022

0.376

1.000010

1

10/14/2022

0.409

1.000034

3

10/17/2022

0.400

1.000011

1

10/18/2022

0.411

1.000011

1

10/19/2022

0.383

1.000011

1

10/20/2022

0.385

1.000011

1

10/21/2022

0.377

1.000031

3

10/24/2022

0.369

1.000010

1

10/25/2022

0.379

1.000011

1

10/26/2022

0.371

1.000010

1

10/27/2022

0.38

1.000011

1

10/28/2022

0.389

1.000032

3

10/31/2022

0.395

1.000011

1

11/1/2022

0.374

1.000010

1

11/2/2022

1.102

1.000031

1

11/3/2022

1.081

1.000030

1

11/4/2022

1.064

1.000089

3

11/7/2022

1.055

1.000029

1

11/8/2022

1.078

1.000030

1

11/9/2022

1.094

1.000030

1

11/10/2022

1.138

1.000032

1

11/11/2022

1.191

1.000099

3

11/14/2022

1.212

1.000034

1

11/15/2022

1.212

1.000034

1

11/16/2022

1.198

1.000033

1

11/17/2022

1.185

1.000033

1

11/18/2022

 

1.000000

3

11/21/2022

 

1.000000

1

11/22/2022

 

1.000000

1

11/23/2022

 

1.000000

1

11/24/2022

 

1.000000

1

11/25/2022

 

1.000000

3

11/28/2022

 

1.000000

1

11/29/2022

 

1.000000

1

11/30/2022

 

1.000000

1

12/1/2022

 

1.000000

1

12/2/2022

 

1.000000

3

12/5/2022

 

1.000000

1

12/6/2022

 

1.000000

1

12/7/2022

 

1.000000

1

12/8/2022

 

1.000000

1

12/9/2022

 

1.000000

3

12/12/2022

 

1.000000

1

12/13/2022

 

1.000000

1

12/14/2022

 

1.000000

1

12/15/2022

 

1.000000

1

12/16/2022

 

1.000000

3

12/19/2022

 

1.000000

1

12/20/2022

 

1.000000

1

12/21/2022

 

 

 

References


All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.

CME Group is the world’s leading derivatives marketplace. The company is comprised of four Designated Contract Markets (DCMs). 
Further information on each exchange's rules and product listings can be found by clicking on the links to CME, CBOT, NYMEX and COMEX.

© 2024 CME Group Inc. All rights reserved.