A repurchase agreement involves the sale of a security with an agreement to repurchase the same security back at a higher price at a later date.
Repo is short for repurchase agreement. Those who deal in government securities use repos as a form of overnight borrowing. A dealer or other holder of government securities (usually T-bills) sells the securities to a lender and agrees to repurchase them at an agreed future date at an agreed price. They are usually very short-term, from overnight to 30 days or more. This short-term maturity and government backing means repos provide lenders with extremely low risk.
The sale of the securities is not truly a sale, but rather a loan secured by the underlying security.
Two main variations on the standard repo include:
· Reverse Repo – The reverse repo is the opposite of a repo. In this case, a dealer buys government securities from an investor and then sells them back at a later date for a higher price
· Term Repo – Exactly the same as a repo except the term of the loan is greater than 30 days.
The repo market
The repo market is significant portion of the money market. The Fed is a major purchaser of repos providing needed liquidity for traders of short-term money market instruments. The repo market is also an important outlet for mutual fund managers of both money market funds and short-term bonds dealing in Treasury securities.