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 secured short-term borrowing, usually, though not always using government securities as collateral. A contracting party sells a security to a lend ...

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 "Financial instrument, instrument") which is secured by a mortgage loan, mortgage or collection of mortgages. The mortgages are aggregated and sold to a group of individuals ( ...

comprising the collateral. The

investor An investor is a person who allocates financial capital with the expectation of a future Return on capital, return (profit) or to gain an advantage (interest). Through this allocated capital the investor usually purchases some species of pr ...

sells a

mortgage-backed security A mortgage-backed security (MBS) is a type of asset-backed security (an "Financial instrument, instrument") which is secured by a mortgage loan, mortgage or collection of mortgages. The mortgages are aggregated and sold to a group of individuals ( ...

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 (legal system), civil law jurisdictions 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 t ...

for a lower price than the sale price. The difference in the prices is called the drop, which is usually priced between SIFMA settlement dates. 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 The Internal Revenue Code of 1986 (IRC), is the domestic portion of federal statutory tax law in the United States. It is codified in statute as Title 26 of the United States Code. The IRC is organized topically into subtitles and sections, co ...

. 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