Dollar Roll
Encyclopedia
A dollar roll is similar to a reverse repurchase agreement
. The investor
sells a mortgage-backed security
for settlement on one date and buys it back for settlement at a later date. The investor gives up the principal and interest payments during the roll period but can invest the proceeds and usually is able to buy back the mortgage
for a lower price than the sale price. The difference in the prices is called the drop. The value of the drop plus interest earned on the proceeds of the sale less the forgone interest and principal payments on the mortgage is considered the roll specialness or financing advantage. However, with repurchase agreements, exactly the same security is returned to the investor, while with dollar rolls, the investor buys a substantially similar security. This difference produces complex results under certain areas of the United States Internal Revenue Code
.
Repurchase agreement
A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is the sale of securities together with an agreement for the seller to buy back the securities at a later date. The repurchase price should be greater than the original sale price, the difference effectively...
. The investor
Investor
An investor is a party that makes an investment into one or more categories of assets --- equity, debt securities, real estate, currency, commodity, derivatives such as put and call options, etc...
sells a mortgage-backed security
Mortgage-backed security
A mortgage-backed security is an asset-backed security that represents a claim on the cash flows from mortgage loans through a process known as securitization.-Securitization:...
for settlement on one date and buys it back for settlement at a later date. The investor gives up the principal and interest payments during the roll period but can invest the proceeds and usually is able to buy back the mortgage
Mortgage loan
A mortgage loan is a loan secured by real property through the use of a mortgage note which evidences the existence of the loan and the encumbrance of that realty through the granting of a mortgage which secures the loan...
for a lower price than the sale price. The difference in the prices is called the drop. The value of the drop plus interest earned on the proceeds of the sale less the forgone interest and principal payments on the mortgage is considered the roll specialness or financing advantage. However, with repurchase agreements, exactly the same security is returned to the investor, while with dollar rolls, the investor buys a substantially similar security. This difference produces complex results under certain areas of the United States Internal Revenue Code
Internal Revenue Code
The Internal Revenue Code is the domestic portion of Federal statutory tax law in the United States, published in various volumes of the United States Statutes at Large, and separately as Title 26 of the United States Code...
.