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Repurchase Agreement
In a repurchase agreement, or repo, one party sells assets or securities to another and agrees to repurchase them at a set price on a set date. It is in essence a short term loan using the assets as collateral. Some central bank use short term repos and reverse repos in government debt as part of their open market operations.
For the party buying the assets it is known as a reverse repo. Repos allow traders to acquire securities and sell them short in the belief that they can be bought back in the market at a cheaper price by the time they must be returned to Party A. The advantage for party A is that it earns added income by lending the securities. Through this operation Party B is effectively a borrower of funds to finance further purchases of securities, and he pays interest to the holder, trader A. The rate of interest used is known as the repo rate. A reverse repo is the reverse situation, whereby the Party A agrees to buy securities from Party B and sell them back at a pre-agreed price and date. Party B is then effectively the lender of funds. A repo agreement allows a borrower to use a security as collateral for a loan at a fixed rate of interest.
A Repurchase agreement (also known as a repo or Sale and Repurchase Agreement) allows a borrower to use a financial security as collateral for a cash loan at a fixed rate of interest. In a repo, the borrower agrees to sell immediately a security to a lender and also agrees to buy the same security from the lender at a fixed price at some later date. A repo is equivalent to a cash transaction combined with a forward contract. The cash transaction results in transfer of money to the borrower in exchange for legal transfer of the security to the lender, while the forward contract ensures repayment of the loan to the lender and return of the collateral of the borrower. The difference between the forward price and the spot price is the interest on the loan while the settlement date of the forward contract is the maturity date of the loan
A repo is economically similar to a secured loan, with the buyer receiving securities as collateral to protect against default. There is little that prevents any security from being employed in a repo; so, Treasury or Government bills, corporate and Treasury/Government bonds, and stocks may all be used as securities involved in a repo.