A repo (repurchase agreement) that is created “synthetically”- that is, from different components- rather than the classic repo in order to replicate the risk/ return profile of a repo. A synthetic repo is constructed using a cash trade in a debt security and a total return swap (TRS) or other types of derivatives (a futures contract, a combination of options, etc).

The derivative(s) can be used as equivalent to the repurchase leg of a repo, transferring the risk and return on the reference asset back to the seller. As in a classic repo, one counterparty gets the cash and the other can use the reference asset. At the end of a synthetic repo, the counterparties usually agree to sell the reference asset back to the original owner at the current price.

For example, a bond repo can be synthesized by combining a spot sale with a forward purchase of of the underlying asset. The bond is sold in the market and the resulting short position in repo is covered. A synthetic repo can also be created using a total return swap (TRS) in which the two counterparties agree to exchange the total return on a specified asset (like a corporate bond) or a portfolio of assets (the reference asset) for a floating rate plus a given spread (a given number of basis points), over a specific period (the swap term). If the reference asset’s yield exceeds the floating rate spread, the funding (carry) will be negative, while it is positive in the opposite scenario. If the underlying asset experiences huge drop in price, the trade will produce gains.