A form
of short-term borrowing
for dealers in
government securities. The
dealer sells the
government securities to investors,
usually on an
overnight basis, and
buys them back
the following day.
For
the party selling the security (and agreeing to repurchase it in the future) it
is a repo; for the party on the other end of the transaction, (buying the
security and agreeing to sell in the future) it is a reverse repurchase
agreement.
Repos
are classified as a money-market instrument. They are usually used to raise
short-term capital.
A
repurchase agreement, also known as a repo 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 spot sale combined with a forward contract. The spot
sale 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 the settlement date of the forward
contract is the maturity date of the loan.