Repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is the sale of securities together with an agreement for the seller to buy back the securities at a later date. The repurchase price should be greater than the original sale price, the difference effectively representing interest, sometimes called the repo rate. The party that originally buys the securities effectively acts as a lender. The original seller is effectively acting as a borrower, using their security as collateral for a secured cash loan at a fixed rate of interest.
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 effectively
the interest on the loan while thesettlement
date of the forward
contract is the maturity date of the loan.
39# Reverse
Repo:
A reverse repo is simply the same repurchase agreement from the buyer's
viewpoint, not the seller's. Hence, the seller executing the transaction would
describe it as a "repo", while the buyer in the same transaction
would describe it a "reverse repo". So "repo" and
"reverse repo" are exactly the same kind of transaction, just
described from opposite viewpoints. The term "reverse repo and sale"
is commonly used to describe the creation of a short position in a debt
instrument where the buyer in the repo transaction immediately sells the
security provided by the seller on the open market. On the settlement date of
the repo, the buyer acquires the relevant security on the open market and
delivers it to the seller. In such a short transaction the seller is wagering
that the relevant security will decline in value between the date of the repo
and the settlement date.