A repurchase agreement, commonly known as a repo, is a financial transaction where a seller of securities agrees to buy them back from the buyer at a later date. This type of agreement is usually used as a short-term source of funding by financial institutions.
In a repo transaction, the buyer (often a bank or other financial institution) lends money to the seller (often a government or large corporation) in exchange for securities. The securities act as collateral for the loan, and the seller agrees to repurchase the securities at a specified date and price.
The price at which the securities are repurchased is predetermined at the time of the transaction and is usually slightly higher than the original purchase price. The difference between the repurchase price and the original purchase price represents the interest earned by the buyer on the loan.
Repos are frequently used by financial institutions to manage their short-term funding needs. For example, a bank may need to borrow cash for a few days to meet its regulatory requirements or to fund its day-to-day operations. By using a repo, the bank can borrow money quickly and at a lower cost than other types of short-term borrowing.
Repos can be classified into two main types: overnight repos and term repos. An overnight repo is a transaction that matures the next business day, while a term repo has a longer maturity period, usually ranging from a few days to several months.
Another type of repo is the reverse repo, where the buyer of the securities agrees to sell them back to the seller at a later date. This type of transaction is often used by the central bank to manage the money supply in the economy.
In summary, a repurchase agreement is a financial transaction where a seller of securities agrees to buy them back from the buyer at a later date. This type of agreement is used by financial institutions to manage their short-term funding needs and is an important tool in the money market.