A dollar roll is similar to a reverse

repurchase agreement A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is a form of short-term borrowing, mainly in government securities. The dealer sells the underlying security to investors and, by agreement between the two pa ...

and provides a form of collateralized short-term financing with

mortgage-backed securities A mortgage-backed security (MBS) is a type of asset-backed security (an 'instrument') which is secured by a mortgage or collection of mortgages. The mortgages are aggregated and sold to a group of individuals (a government agency or investment ba ...

comprising the collateral. The

investor An investor is a person who allocates financial capital with the expectation of a future return (profit) or to gain an advantage (interest). Through this allocated capital most of the time the investor purchases some species of property. Type ...

sells a

mortgage-backed security A mortgage-backed security (MBS) is a type of asset-backed security (an 'instrument') which is secured by a mortgage or collection of mortgages. The mortgages are aggregated and sold to a group of individuals (a government agency or investment b ...

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 A mortgage loan or simply mortgage (), in civil law jurisdicions known also as a hypothec loan, is a loan used either by purchasers of real property to raise funds to buy real estate, or by existing property owners to raise funds for any ...

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. With repurchase agreements exactly the same security is returned to the investor, while with dollar rolls the investor buys a substantially similar—but not necessarily identical—security. This difference produces complex results under certain areas of the United States Internal Revenue Code. Dollar rolls help investors achieve various objectives, such as staying invested in mortgages while earning a trading spread. Likewise, if an investor faces operational or delivery obstacles with respect to a certain mortgage-backed security, a dollar roll may help the investor retain the economic exposure while avoiding the operational difficulties.

References

Derivatives (finance) {{econ-stub