http://awgmain.morningstar.com/webhelp/Advisor_Workstation_Office.

htm#Import/The_Import_Proc
ess/Importing_Data_into_Morningstar_Office_Overview.htm (for details on Morning Star)

Repo vs. Reverse Repo: What's the Difference?

Updated Apr 26, 2019

Repo vs. Reverse Repo: An Overview
The repurchase agreement (repo or RP) and the reverse repo agreement (RRP) are key tools used by
many large financial institutions, banks, and some businesses. These short-term agreements provide
temporary lending opportunities that help to fund ongoing operations. The Federal Reserve also uses
the repo and reverse repo agreements as a method to control the money supply.

In short, a repo is an agreement between parties where the buyer agrees to temporarily purchase a
basket or group of securities for a specified period. The buyer agrees to sell those same assets back to
the original owner at a slightly higher price using a reverse repo agreement.

These agreements are termed as collateralized lending because a group of securities—most frequently
U.S. government bonds—secures the short-term loan agreement. Further, both the repurchase and
reverse repurchase portions of the contract are determined and agreed upon at the outset of the deal.

Repo
A repurchase agreement (RP) is a short-term loan where both parties agree to the sale and future
repurchase of assets within a specified contract period. The seller sells a Treasury bill or other
government security with a promise to buy it back at a specific date and at a price that includes an
interest payment.

Repurchase agreements are typically short-term transactions, often literally overnight. However, some
contracts are open and have no set maturity date, but the reverse transaction usually occurs within a
year.

Dealers who buy repo contracts are generally raising cash for short-term purposes. Managers of hedge
funds and other leveraged accounts, insurance companies, and money market mutual funds are among
those active in such transactions.

A repurchase agreement involves a sale of assets. However, for tax and accounting purposes it is treated
as a loan.
Securing the Repo
The repo is a form of collateralized lending. A basket of securities acts as the underlying collateral for the
loan. Legal title to the securities passes from the seller to the buyer and returns to the original owner at
the completion of the contract. The collateral most commonly used in this market consists of U.S.
Treasury securities. However, any government bonds, agency securities, mortgage-backed securities,
corporate bonds, or even equities may be used in a repurchase agreement.

Securities Gyan Page 1

The value of the collateral is generally greater than the purchase price of the securities. The buyer
agrees not to sell the collateral unless the seller defaults on their part of the agreement. At the contract
specified date, the seller must repurchase the securities including the agreed upon interest or repo rate.

In some cases, the underlying collateral may lose market value during the period of the repo agreement.
The buyer may require the seller to fund a margin account where the difference in price is made up.

The Federal Reserve Use of Repo Agreements

Standard and reverse repurchase agreements are the most commonly used instruments of open market
operations for the Federal Reserve.

The Central Bank can boost the overall money supply by buying Treasury bonds or other government
debt instruments from commercial banks. This action infuses the bank with cash and increases its
reserves of cash in the short term. The Central Bank will then resell the securities back to the banks.

When the Central Bank wants to tighten the money supply—removing money from the cash flow—it
sells the bonds to the commercial banks using a repurchase agreement, or repo for short. Later, they
will buy back the securities through a reverse repo, returning money to the system.

Disadvantages of Repos
Repo agreements carry a risk profile similar to any securities lending transaction. That is, they are
relatively safe transactions as they are collateralized loans, generally using a third party as a custodian.

The real risk of repo transactions is that the marketplace for them has the reputation of sometimes
operating on a fast-and-loose basis without much scrutiny of the financial strength of the counterparties
involved, so, some default risk is inherent.

There also is the risk that the securities involved will depreciate before the maturity date, in which case
the lender may lose money on the transaction. This risk of time is why the shortest transactions in
repurchases carry the most favorable returns.

Reverse Repo
A reverse repurchase agreement (RRP) is an act of buying securities with the intention of returning—
reselling—those same assets back in the future at a profit. This process is the opposite side of the coin
to the repurchase agreement and is simply a matter of perspective. To the party selling the security with
the agreement to buy it back, it is a repurchase agreement. To the party buying the security and
agreeing to sell it back, it is a reverse repurchase agreement. The reverse repo is the final step in the
repurchase agreement closing the contract.

In a repurchase agreement, a dealer sells securities to a counterparty with the agreement to buy them
back at a higher price at a later date. The dealer is raising short-term funds at a favorable interest rate
with little risk of loss. The transaction is completed with a reverse repo. That is, the counterparty has
sold them back to the dealer as agreed.

The counterparty earns interest on the transaction in the form of the higher price of selling the
securities back to the dealer. The counterparty also gets the temporary use of the securities.

Securities Gyan Page 2

Special Considerations
The purpose of the repo is to borrow money, yet it is not technically a loan. Ownership of the securities
involved actually passes back and forth between the parties involved.

Nevertheless, they are very short-term transactions with a guarantee of repurchase. Thus, for tax and
accounting purposes repo agreements are generally treated as loans.

KEY TAKEAWAYS:

 The repurchase agreement is a form of short-term borrowing used in the money markets.
 Although it is considered a loan, the repurchase agreement involves the sale of an asset that is
held as collateral until it the seller repurchases it at a premium.
 The seller is making a repurchase agreement. In money markets lingo, the buyer is making a
reverse repurchase agreement.

https://fincad.com/resources/resource-library/wiki/types-credit-derivatives

TYPES OF CREDIT DERIVATIVES

A credit derivative is a financial instrument that transfers credit risk related to an underlying entity or a
portfolio of underlying entities from one party to another without transferring the underlying(s). The
underlyings may or may not be owned by either party in the transaction. The common types of credit
derivatives are Credit Default Swaps, Credit Default Index Swaps (CDS index), Collateralized Debt
Obligations, Total Return Swaps, Credit Linked Notes, Asset Swaps, Credit Default Swap Options, Credit
Default Index Swaps Options and Credit Spread Forwards/Options.
To download the latest trial version of FINCAD Analytics to calculate credit derivatives, contact a FINCAD Representative.

Credit Default Swaps

In a credit default swap the seller agrees, for an upfront or continuing premium or fee, to compensate
the buyer when a specified event, such as default, restructuring of the issuer of the reference entity, or
failure to pay, occurs. Buyers of credit default swaps can remove risky entities from their balance sheets
without selling them. Sellers can gain higher returns from investments or diversify their portfolios by
entering markets that are otherwise difficult to get into.

The value of a default swap depends not only on the credit quality of the underlying reference entity but
also on the credit quality of the writer, also referred to as the counterparty. If the counterparty defaults,
the buyer of a default swap will not receive any payment if a credit event occurs. We also note that if a
counterparty defaults, the premium payments end. Hence, the value of a default swap depends on the
probability of counterparty default, probability of entity default and the correlation between them.

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Credit default swaps are composed of the following four types: credit default swaps on single entities,
credit default swaps on a basket of entities, credit default index swaps, and first-loss and tranche-loss
credit default swaps.

 Credit Default Swaps on Single Entities: a credit default swap on a single entity. This is the
most common type of credit default swaps.
 Credit Default Swaps on Baskets of Entities: A basket default swap is similar to a single
entity default swap except that the underlying is a basket of entities rather than one single
entity.
 First-Loss and Tranche-Loss Credit Default Swaps: Similar to a first-to-default or an nth-to-
default credit default swap, a first-loss credit default swap (FLCDS) protects its buyer from
losses of a reference pool as a result of credit events. Unlike a first-to-default credit default
swap, in which only the loss from the first credit event is compensated, or an nth -to-default
credit default swap, in which the losses from the nth default or the first n default s are
compensated, an FLCDS compensates its buyer for any losses from credit events of the
reference assets up to a certain portion of the total notional of the asset pool.
 Credit Default Index Swaps (CDS Index): A credit default index swap (CDIS) is a por tfolio of
single-entity credit default swaps (CDS). It can be seen as an extension of a CDS on a single -
entity to a portfolio of entities. The basic difference is that in a CDS the notional is fixed
during the life of the CDS and the protection buyer is compensated at most once, while in a
CDIS the premium notional is variable. Whenever a default in the portfolio occurs, the
premium notional is reduced by the loss amount of the defaulted entity and at the same
time the protection buyer gets compensated by the lost amount. The most popular credit
default index swaps are the so-called standardized credit default index swaps. In these
standardized contracts the reference credit pool is homogeneous, that is, all the reference
entities have the same notional and the same recovery rate. Typical examples of
standardized CDISs are the CDX index and the ITRAXX index.

Total Return Swaps

A total return swap is a means to transfer the total economic exposure, including both market and
credit risk, of the underlying asset. The payer of a total return swap can confidentially remove all the
economic exposure of the asset without having to sell it. The receiver of a total return swap, on the
other hand, can access the economic exposure of the asset without having to buy the asset. Typical
reference assets of total return swaps are corporate bonds, loans and equities.

Securities Gyan Page 4

Credit-Linked Notes
A credit-linked note, also known as a credit default note, is a fixed or floating rate note where the
principal and/or coupon payments are referenced to a credit or a basket of credits. If there is no credit
event of the reference credit(s), all the coupons and principals will be paid in full. However, if there is a
credit event, the payments of the principal and, possibly, also the coupon of the note will be reduced.

Credit Default Swap Options

A credit default swap option is also known as a credit default swaption. It is an option on a credit
default swap (CDS). A CDS option gives its holder the right, but not the obligation, to buy (call) or sell
(put) protection on a specified reference entity for a specified future time period for a certain spread.
The option is knocked out if the reference entity defaults during the life of the option. This knock-out
feature marks the fundamental difference between a CDS option and a vanilla option. Most commonly
traded CDS options are European style options.
Similar to the credit default swaps, CDS options can be: CDS options on a single entity with a regular
payoff for the default leg; CDS options on a single entity with a binary payoff for the default leg; CDS
options on a basket of entities with regular payoff for the default leg; and CDS options on a basket of
entities with a binary payoff for the default leg.

Credit Default Index Swap Options

A credit default index swap option (CD index swap option, or CD index swaption, or CDS index option) is
an option to buy or sell the underlying CDIS at a specified date. A payer swaption gives the holder of the
option the right to buy protection (pay premium) and a receiver swaption gives the holder of the option
the right to sell protection (receive premium). Unlike a CD index swap, which is a natural extension of a
CDS on a single-entity to a CDS on a portfolio of entities, a CD index swaption is significantly different
from a CDS option, an option on a single-entity CDS. In the case of an option on a single-entity, if the
reference entity defaults before the option's expiry, the option will be knocked out and become
worthless. For an option on a CDIS, when a reference entity defaults before the option's expiry, the loss
will be paid by the protection seller to the protection buyer when the option is exercised. Even if there is
only one entity in the portfolio, a CD index swaption is still different from a single-entity CDS option: if
the entity defaults before expiry, the option's seller will pay to the protection buyer the lost amount at
expiry. Clearly, a CD index swaption is always more valuable than a single-entity CDS option.

Credit Spread Options and Forwards

Credit spread options are options where the payoffs are dependent on changes to credit spreads. The
transaction may be either based on changes in a credit spread relative to a risk-free benchmark (e.g.

Securities Gyan Page 5

LIBOR or US Treasury) or changes in the relative spread between two credit instruments. A credit spread
option may be a vanilla option or an exotic option, such as an Asian option, a lookback option, etc. The
option style may be European or American. Valuation of credit spread options can be based on modeling
the two underlying instruments or modeling the credit spread only.

Asset Swaps
An asset swap is a combination of a defaultable bond with a fixed-for-floating interest rate swap that
swaps the coupon of the bond into the cash flows of LIBOR plus a spread. In the case of a cross currency
asset swap, the principal cash flow may also be swapped. In a typical asset swap, a dealer buys a bond
from a customer at the market price and sells to the customer a floating rate note at par. The dealer
then enters into a fixed-for-floating swap with another counterparty to offset the floating rate obligation
and the bond cash flows. For a premium bond, the dealer pays to the customer the difference of the
bond price and its par. For a discount bond, the customer pays to the dealer the difference of the par
and the bond price. In the swap with the counterparty the dealer pays a fixed bond coupon and receives
LIBOR + a spread. The spread can be determined from the cash that the dealer pays/receives and from
the difference of the bond coupon and the par swap rate.

Synthetic Collateralized Debt Obligations (CDOs)

Synthetic CDOs are credit derivatives on a pool of reference entities that are "synthesized" through
more basic credit derivatives, mostly, credit default swaps (CDSs) and credit linked notes (CLNs). A
common structure of CDOs involves slicing the credit risk of the reference pool into a few different risk
levels. The level with a higher credit risk supports the levels with lower credit risks. The risk range of two
adjacent risk levels is called a tranche. The lower bound of the risk level of a tranche is often referred to
as an attachment point and the upper bound a detachment point. The most common CDO credit
derivatives are CDSs on CDO tranches and CDO notes (tranche-linked notes or CLN on tranches). The
most popular synthetic CDOs are the so-called standardized CDOs (sometimes are simply called
standardized tranches). For a standardized CDO its reference entities are homogenous, i.e., all the
reference entities have the same notional and the same recovery rate. Due to the complexity and the
large sizes of reference pools of synthetic CDOs, their valuation is much more complicated and resource
intensive than the ordinary single-entity or basket CDSs and CLNs. Monte Carlo methods have been the
most reliable methods in CDO valuation but they are not efficient in computation. Recently, thanks in
part to the standardization of the synthetic CDO market, quasi-analytic methods, such as the fast Fourier
transform (FFT), are gaining popularity. These methods are much more efficient than Monte Carlo
simulation for CDOs whose reference entities have "good" homogeneity and, particularly, when the one-
factor copula model is used for modeling credit correlation.

Securities Gyan Page 6

Correlations are one of the key factors in CDO valuation. Given the spread of a tranche one would like to
back out, when the one-factor Gaussian copula model is used, the correlation that gives the tranche's
par spread as the given spread. Such a correlation is called a tranche correlation. Research shows that
tranche correlation is not unique except for the equity tranche. For this reason the implied correlations
of tranches that have an attachment of 0 have become more attractive than tranche correlations. Such
correlations are known as base correlations. Since market quotes are available only for regular tranches,
to back out the base correlations of all trachea of a synthetic CDO, the so-called bootstrapping algorithm
must be used.

Equity Derivatives

 Equity Options
 Equity Index Options
 Equity Index Futures
 Equity Forward
 Equity Swap
 Equity Variance Swap
 Equity Volatility Swap
 Equity Variance Option
 Equity Volatility Option
 Equity Warrants
 Equity Convertibles
 Equity Convertible Swaps
 Equity Convertible Preferreds

Interest Rate Derivatives

 Bond Futures
 Interest Rate Futures
 Futures on Swaps
 Options on Bond Futures
 Options on Interest Rate Futures
 Interest Rate Swap
 Cross-Currency Swap

Securities Gyan Page 7

  Bond Forwards
 FRA – Floating Rate Agreements
 Structured Products (Notes/Bonds/Bills)

FX Derivatives

 FX Futures
 FX Forwards
 FX Listed Options
 FX OTC Options
 Currency-linked Notes
 Currency Swaptions

Credit Derivatives

 Credit Default Swap- Single Names

 Credit Default Swap – Basket
 Credit Default Swap – Index

PIPEs are privately negotiated investments in newly issued equity (or equity-linked instruments) of a
publicly listed company. PIPE is best defined by decomposing the
acronym:

 Private: A privately negotiated transaction between a company and the investor or a

limited group of investors. The offer is not made public and transaction terms are
individually negotiated.

 Investment: Direct investment in a company. The investor buys newly issued equity and the
proceeds directly benefit the company.

 Public: The stocks of the issuing company are publicly listed on a stock exchange.

 Equity: The PIPE investor invests in equity or an equity-linked security (e.g. convertible debt).
This means the investor directly or indirectly acquires some degree of ownership in the
company.

 The securities in a PIPE transaction are often issued at a significant discount to the current
market price (average discounts are estimated to be between 18% and 32%).

Securities Gyan Page 8

 Most PIPE deals are structured as plain vanilla common stock purchases – about 60% of all deals in
2007/2008; Other very common deal structures are convertible
debt (25% of all deals in 2008) and convertible preferred stock (12% of all deals in 2008). In
addition, many deals contain warrants as an extra equity kicker.

PIPEs are usually categorized as “traditional PIPEs”, i.e. plain vanilla common stock or fixed-price
convertibles, and “structured PIPEs”, which have some kind of implicit price protection (e.g. floating
rate convertible preferred stock, convertible resets).

Who is doing PIPEs? Most PIPE issuers are rather young, small and risky companies; such as
technology and biotech firms, which went public very early in their corporate lifecycle and are
seeking fresh money.

Many different types of institutional investors engage in PIPE deals. Among the most active
categories are hedge funds (45% of all deals in 2008), private equity funds (12%), financial institutions
(7%) and sovereign wealth funds (1%).

What Is Tax Lot Accounting?

Tax lot accounting is a record-keeping technique that traces the:
1. dates of purchase and
2. date of sale,
3. cost basis (ie FIFO, LIFO, Average Cost method etc), and
4. transaction size
for each security in your portfolio, even if you make more than one trade in the same security.

BREAKING DOWN Tax Lot Accounting

Shares purchased in a single transaction are referred to as a lot for tax purposes. When shares of the
same security are purchased, the new positions create additional tax lots. The tax lots are multiple
purchases made on different dates at differing prices. Each tax lot, therefore, will have a different cost
basis. Tax lot accounting is the record of tax lots. It records the cost, purchase date, sale price, and sale
date for each security held in a portfolio. This recordkeeping method allows an investor to track each
stock sale throughout the year so that s/he can make strategic decisions about which lot to sell and when
bearing in mind that the type of investment tax to be paid will depend on how long the stock was held
for.

Tax lot accounting is primarily the record-keeping of tax lots.

For example, assume an investor purchased 100 shares of Netflix in March 2017 for $143.25 and another
100 shares in July 2017 for $184.15. In April 2018, the value of NFLX stock has risen to $331.45. His first
tax lot has been held for more than a year, but the most recent lot has been held for less. The Internal
Revenue Service (IRS) imposes a long-term capital gains tax on the profit made from the sale of a security
held for more than a year. This tax is more favorable than the ordinary income tax applied to capital
gains on stock held for less than a year. If the investor decides to sell, say 120 shares, how long the
investments were held for must be recorded. Also, he must factor in the fact that the newer tax lot will
have a smaller capital gain if sold, which may translate to lower tax than that of the older lot.

Securities Gyan Page 9

If he chooses to sell shares from the March lot, he will be using the First-In First-Out (FIFO) method of tax
lot accounting in which the first shares purchased are the first shares sold. In this case, the long-term
capital gains tax will apply. Selling 120 shares will mean that his March acquisition will be sold, and the
remaining 20 shares will come from the second lot. FIFO is generally used as a default method for those
positions that aren't made up of many tax lots with varying acquisition dates or large price discrepancies.

If the shares sold are elected to come from the July lot, this choice will follow the Last-In First-Out (LIFO)
method of accounting, and the realized gains will be taxed as ordinary income. If he sells 120 shares, 100
shares will be sold from the July lot and the remaining 20 shares will be sold from the March lot.

Other tax lot accounting methods include the average cost basis, highest cost, lowest cost, and tax-
efficient harvester loss methods.

The goal of tax lot accounting is to minimize the net present value of current taxes by deferring the
realization of capital gains and recognizing losses sooner.

What Is Tax-Loss Harvesting?

Tax-loss harvesting is the selling of securities at a loss to offset a capital gains tax liability. This strategy is
typically employed to limit the recognition of short-term capital gains. Short-term capital gains are
generally taxed at a higher federal income tax rate than long-term capital gains. However, the method
may also offset long-term capital gains.

Breaking Down Tax-Loss Harvesting

Tax-loss harvesting is also known as "tax-loss selling." Usually, this strategy is implemented near the end
of the calendar year but may happen at any time in a tax year. With tax-loss harvesting, an investment
that has an unrealized loss is sold allowing a credit against any realized gains which occurred in the
portfolio. The asset sold is then replaced with a similar asset to maintain the portfolio's asset allocation
and expected risk and return levels.

For many investors, tax-loss harvesting is the most critical tool for reducing taxes. Although tax-loss
harvesting cannot restore an investor to their previous position, it can lessen the severity of the loss. For
example, a loss in the value of Security A could be sold to offset the increase in the price of Security B,
thus eliminating the capital gains tax liability of Security B.

Tax-loss harvesting allows investments with unrealized losses to be sold and credited against realized
gains.
Tax-Loss Harvesting Example
Assume an investor as of 2019, has the income that puts that person into the highest capital gains tax
category (more than $434,551 if single, $488,850 if married filing jointly). They sold investments and
realized long-term capital gains, which are subject to a tax rate of 20%. Below are the investor's portfolio
gains and losses and trading activity for the year:

Portfolio:

 Mutual Fund A: $250,000 unrealized gain, held for 450 days

 Mutual Fund B: $130,000 unrealized loss, held for 635 days
 Mutual Fund C: $100,000 unrealized loss, held for 125 days

Securities Gyan Page 10

Trading Activity:

 Mutual Fund E: Sold, realized a gain of $200,000. Fund was held for 380 days
 Mutual Fund F: Sold, realized a gain of $150,000. Fund was held for 150 days

Without tax-loss harvesting, the tax liability from this activity is:

 Tax without harvesting = ($200,000 x 20%) + ($150,000 x 37%) = $40,000 + $55,500 = $95,500

If the investor harvested losses by selling Mutual Funds B and C, they would help to offset the gains, and
the tax liability would be:

 Tax with harvesting = (($200,000 - $130,000) x 20%) + (($150,000 - $100,000) x 37%) = $14,000 +
$18,500 = $32,500

The proceeds of the sales may then reinvested in assets like the ones sold, although IRS rules dictate
that investors must wait at least 30 days before purchasing another asset that is “substantially identical”
to the asset that was sold at a loss for tax loss harvesting purposes. This can help preserve the value of
the investor’s portfolio while defraying the cost of capital gains taxes on the profits of the sales of
Mutual Fund E and Mutual Fund F. Using the tax loss harvesting strategy, investors can realize significant
tax savings.

Related Terms

RobinHood Tax Lot: Robinhood uses the “First In, First Out” method. This means that your
longest-held shares are recorded as having been sold first when you execute a sell order. The
shares themselves are not specifically tracked, but the cost associated with those shares is
expensed first.

Robo Tax Loss Harvesting

Robo tax-loss harvesting is the automated selling of securities in a portfolio to deliberately incur losses
to offset any capital gains or taxable income.
Tax Loss Carryforward
A tax loss carryforward is an opportunity for a taxpayer to carry over a tax loss to a future time in order
to offset a profit.
Unrealized Gain Definition
An unrealized gain is a potential profit that exists on paper, resulting from an investment. It is an
increase in the value of an asset that has yet to be sold for cash.
What is Crystallization?
Crystallization is the act of selling and buying stocks almost instantaneously in order to increase or
decrease book value.
Capital Loss Carryover
Capital loss carryover is the amount of capital losses a person or business can take into future tax years.

Securities Gyan Page 11

 Tax Lot Data Discrepancies and Reconciliation Options
(http://awgmain.morningstar.com/webhelp/Import/Tax_Lot_Data_Discrepancies_and_Reconciliation_Options.htm

Tax Lot Data Discrepancies

There are a number of reasons why your custodian’s open lot and cost file may not match to Morningstar’s
calculated open lots. Here are some common reasons:
1. When you first started importing into Morningstar Office, you most likely went through the initialization
process, which creates a single Deliver-In transaction for each holding in your accounts using the
holding file provided by your custodian. This initial lot will most likely not reconcile with your custodian
lot file because your holding is made up of multiple lots. This requires the Split Initialized Lots option
(see Split Initialized Lots section).
2. Many custodians do not provide the lot matching method on their closing transactions (FIFO, LIFO,
Specified, etc.). For this case, Morningstar Office relies on the default matching method setting for the
holding. If the closing transactions’ matching method does not match the Morningstar method, the
Morningstar open lots may not match the custodian open lots. This requires the View/Edit Transaction
update to edit the closing transaction.
3. There may be a security that was delivered into the account with missing cost basis information. This
requires the Update Cost to Custodian option.
4. Many custodian trading platforms have sophisticated tax lot optimizer algorithms that specify which lots
to close. This requires the Specify Lot option.
5. The security may have incurred a corporate action and the cost calculation methodology may be slightly
different. For example, there may be a difference in the fair market value calculation. This requires
the Update Cost to Custodian option.
6. There may be a wash sale cost adjustment that Morningstar Office has not considered. This requires the
Update Cost to Custodian option.
7. There may be a Return of Principal cost adjustment that Morningstar Office has not considered. This
requires the Update Cost to Custodian option.

Tax Lot Reconciliation Options

There are three functions that help you reconcile the latter two outcomes: Splitting Initialized Lots, Re-
Initializing Lots, and manually editing tax lots.

Split Initialized Lots

Splitting Initialized Lots is a process by which users can simply override open tax lot data (that is either price,
number of shares or acquisition date) in Morningstar Office with the data the custodian provides. This detailed
and precise process results in Office data most accurately mirroring the custodian data.
Users most likely to use this method want to account for historical transactions that affect tax lots or who want
to produce accurate realized gain/loss reports.
Partially closed lots cannot be split, however you can manually update the transactions related to those lots.
Here’s a simple and straightforward example of why you might consider splitting open lots. After you initialize or
import your client and account data, your client owns 100 share of ABC fund which, in office, is accounted for
with one Deliver-In transaction of 100 shares. But, after importing your tax lots, you find out that the 100
shares was really the result of two buys, we’ll say 75 shares on a certain day and 25 shares on a different day.
With Splitting lots, Office provides functionality to break that single Deliver-in of 100 shares into 2 deliver-ins
with the correct acquisition date, price, and number of shares.
Click here for step-by-step instructions to Split Initialized Lots.

Re-Initialize Lots
The Re-Initialized Lots option is the easiest way to create a new baseline using the open lot and cost data from
your custodian. However, you should carefully consider whether or not to use this option.
The Re-Initialized Lots option will generate a single Debit transaction for the entire open holding(s) you have
selected in Morningstar's system. Additionally, the option will generate multiple Credit transactions
corresponding to each open lot record from your custodian. Each Credit transaction will be created with the
original cost that your custodian is providing. The end result of the holding amount(s) will be the same, but now
your open lot and cost data will be in sync with your custodian.

Securities Gyan Page 12

 Users most likely to use this method might want to create a new beginning point with custodian provided tax
data; produce unrealized gain/loss reports; have a position with months or years of complicated transactions
which can’t be easily tracked, audited, or deciphered; or the user doesn’t want to manually edit transactions for
positions containing partially closed lots.
There are some items you should consider before using this Re-Initialize Lots option.
Creating Debit and Credit transactions as of your import lot file will only ensure that your lot and cost data is
correct moving forward. This option will not correct any historical transactions that have occurred prior to this
new baseline you are establishing.
Therefore, if you run a Gain/Loss report for a date range that spans across this new baseline, the result could be
inaccurate. Only a date range after this new baseline should be considered.
There are some items you should consider before using this Re-Initialize Lots option.
If you want to correct your entire transaction history for the un-reconciled lots, you can start with the Split
Initialized Lots option to split your initial Deliver-In transaction into multiple lots with correct cost. You can also
verify your existing, closing transaction to ensure the tax lot accounting method is correct and Morningstar has
closed the correct lot(s). This is a more time-consuming approach.
Both of the two reconciliation methods are precise in that the custodian’s data is brought into Office, however
the more intricate process of splitting initialized lots results in more accurate reporting.

Manually Editing Lots

Manually editing lots is an appropriate option to reconcile lots as long as the user can provide the data and enter
it in Office. In this method, a user can view an un-reconciled position and edit the transactions manually with
the correct number of shares, share price, or acquisition date.
Manual editing is generally used in conjunction with the Splitting Initialized Lots reconciliation method because it
is not uncommon to have partially closed lots as part of the import file. And, as stated previously, the primary
reason for using the splitting lots reconciliation method is to generate accurate realized gain loss reports.
For additional frequently asked questions regarding the importing and reconciliation of tax lots, access the FAQ
here.

Troubleshooting Guide for Common Import and Reconciliation Issues

http://awgmain.morningstar.com/webhelp/Import/The_Import_Process/Troubleshooting_Guide_for_Common_Import_and_R
econciliation_Issues.htm

Overview
Custodian interfaces provide a means for electronically populating client data in the Office product. However, no
interface is perfect, and there will always be some situations that must be manually corrected. The Import
Blottershighlight items that should be reviewed and corrected before adding the data into your system. This
topic will cover some of the most common issues that arise during the import and reconciliation process.
Reconciliation Issues and Instructions on How to Fix Them
Helpful Tools to Assist with the Reconciliation Process

What is reconciliation and Out of Balances (OOB)?

Reconciliation is the process of comparing the share balance in Morningstar to the custodian. Ultimately,
you want your Morningstar accounts to reflect the same share balance and activity that occurred at the
custodian. An Out of Balance (OOB) is when there is a share balance discrepancy.

How often will I get reconciliation issues?

During the import process, it is expected that you will, from time to time, have reconciliation OOB. This
is due to the translation process involved to get the data from one platform to another. You should
account for this and should expect to spend time on a periodic basis reconciling your data. The amount
of time that you will need to spend on reconciliation issues will depend on how many accounts you are
importing, the complexity of the accounts that you import, and the Custodian that you are importing
from.

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 Why do I get reconciliation issues?
Reconciliation issues result from the translation process. This process is stated below.

1.
1. The transactions are recorded at the custodian.
2. These transactions are then translated by the custodian and given transaction codes to
represent the transaction\event that occurred. This process occurs during the file creation
process, which usually takes place daily.
3. Morningstar will then translate the transaction codes provided in the custodian files into the
most appropriate transaction type available within the Morningstar Office program.
Due to this double translation process there is room for error. Sometimes the same transaction code is
used to represent multiple scenarios or there is not a great transaction code to represent a unique
situation. Morningstar will use the most popular transaction type for each transaction code, however,
this may not be accurate in all instances where this transaction code is used. Morningstar uses all of the
information available within the files to choose the best transaction type, including the transaction code
and comments provided. If you feel that a transaction is not being imported correctly based on the
information provided, please call Morningstar Support at 1-866-215-2503 and we will investigate the
specific scenario.

Are there certain transactions\events that are more likely to cause reconciliation issues?
There are certain transactions\events that are unique and often cause reconciliation issues due to the
inability to capture all of the details within the files that are required to correctly process the
transactions within Morningstar Office. The most common scenarios include corporate actions, reversals,
tender offers, and symbol changes.

How can I reduce the reconciliation issues I receive?

The best way to reduce reconciliation issues is to import daily. This will reduce error by ensuring that
you receive the needed files each day. This will also allow you to research out and resolve reconciliation
issues on the day they are received, thus reducing the amount of data to look through to determine the
resolution.
Note: Pershing should be imported weekly and DST fund companies can only be reconciled monthly.

What do the colors red and blue signify in the Failed Blotter?
Both colored OOB are share discrepancies between Morningstar and the Custodian that need to be
resolved. Below is a description of what each color represents.
Red - Items in red indicate that the custodian recognizes a position but Office recognizes a different
position (either no position or just different).
Blue - Items in blue indicate that Office has a position in the holding but the custodian has a zero
position in the holding.

Reconciliation Issues and Instructions on How to Fix Them

 Cash OOB - Refer to these steps when you only have a Cash OOB for an account.
 Holding OOB - Refer to these steps when you have a Holding OOB (except Cash) for an account.
 Tender Offers – Follow these steps when a Tender Offer occurs.
 New Accounts – Follow these steps when you have a new account that transferred into your custody.
 Fatal Error – Follow these steps if you received a fatal error while importing or posting.
 Closed Accounts – Follow these steps when you have a closed account that has transferred out of your
custody.
 Long/Short Option Issues - Follow these steps if you receive a long/short position type issue for an
option.

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  Spin-offs - Refer to the Corporate Action Spin-off Wizard for step by step instructions on how to handle
a spin-off.
 Mergers/Exchanges - Refer to the Merger/Exchange Wizard for step by step instructions on how to
handle a merger or exchange.
 Splits - Refer to Split/Reversal Split Wizard for step by step instructions on each screen within the
Split/Reverse Split Wizard.
 Ticker/CUSIP Changes - Follow these steps when a Ticker/CUSIP change occurs.
 Security Mapping Issues - Follow these steps when there is a Security Mapping issue.
Helpful Tools to assist with the Reconciliation Process
 Viewing and Removing Your Post History - Morningstar keeps a record of your post history for each
custodian and interface type from which you import. You can view information about the transactions
you posted, and you can remove transactions you have posted.
 Reconciling Historically - Use the Reconcile Historical Date function to reconcile as of a date that is
within the date range you are currently importing. This function is helpful if you are importing a large
date range and need to determine when the OOB first occurred or if you are importing missing files.
 Microsoft Excel Import - The Excel Import can be used to fix common OOB due to missing
transactions when you are unable to download the needed transactions from the custodian. It is often
quicker to use Excel than manually adding them. Click here to see how to do this.
 Find Transactions - Use the Find Transactions utility if you need to find transactions globally,
throughout your practice. This is helpful if you need to edit, delete, or export transaction to Excel for a
certain security or within a certain transaction type that spans across many accounts.
 Importing Duplicate Transactions – There may be unique scenarios when you need to import data
that has duplicate transactions in it. Refer to Removing Duplicate Transactions when Posting for step by
step instructions on removing these duplicate transactions.
 Importing Missing Files – Refer to Importing Missing Files for step by step instruction on importing
missing files when you have imported and posted data after the file date you are missing.

 Exclusions

 Use the Excluding an Account from Importing and Reconciliation instructions to exclude an
account from importing for a custodian.
 Use the Import Security Exclusion instructions to exclude a security from importing for a
custodian entirely or from just one account at that custodian.
 Use the Exclude Holding from Reconciliation instructions to exclude a holding that is held in the
Morningstar account but that you do not want to show up during reconciliation - Example: an
unmanaged asset.

See Also

P&L Reconciliation (https://onlinelibrary.wiley.com/doi/10.1002/9781118939789.ch14)

There are two primary profit and loss (P&L) reconciliations performed by product control. These are:

1. the comparison of the front office estimate to product control's P&L and
2. the comparison of the P&L in the general ledger (GL) to that reported by product control.

This chapter focuses on both these reconciliations and will also review the front office P&L sign off,
which is another important control which product control interact with. One of the key controls
maintained by product control is the comparison of the flash to the actual P&L produced by product
control. An accurate flash is important as it shows the desk understand their book, which includes

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 its trading activity, existing risk and the market rates used to revalue their portfolio. The P&L sign‐
off is an important internal control as any late, missing or rejected sign‐offs could indicate that
there is a problem with the P&L.

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