Repurchase Agreement
IntermediateA repurchase agreement is a short-term borrowing arrangement in which one party sells securities, usually government bonds, to another and agrees to buy them back at a slightly higher price on a set future date.
A repurchase agreement, commonly called a repo, is effectively a secured loan. The seller receives cash and the buyer receives securities as collateral. When the agreement ends, the seller repays the cash plus interest by buying back the securities at a higher price. The difference between the two prices represents the interest, known as the repo rate.
For example, a bank sells government bonds worth 10 million to an investor and agrees to buy them back the next day for 10,001,000. The bank has effectively borrowed 10 million overnight, paying 1,000 in interest.
From the other side, the transaction is called a reverse repo: the investor lends cash and receives securities as collateral.
Repos are widely used by banks, investment funds, money market funds and central banks. They are a key source of short-term funding and a major tool for central banks implementing monetary policy. Because the loan is backed by collateral, repo rates are usually lower than unsecured borrowing rates. Lenders often apply a haircut, lending slightly less than the collateral's value, to protect against falls in its price.
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