Glossary term
Repurchase Agreement (Repo)
A repurchase agreement, or repo, is a short-term financing transaction where one party sells securities and agrees to buy them back later, usually at a slightly higher price.
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What Is a Repurchase Agreement (Repo)?
A repurchase agreement, or repo, is a short-term financing transaction where one party sells securities and agrees to buy them back later, usually at a slightly higher price. Economically, it functions like a collateralized loan, with securities serving as collateral and the price difference acting like interest.
Repos are common in money markets, bank funding, dealer financing, and central-bank operations. They are part of the plumbing behind short-term liquidity, not a typical household borrowing product.
Key Takeaways
- A repo is a short-term sale-and-repurchase transaction.
- It functions economically like secured borrowing.
- Securities, often Treasury securities, serve as collateral.
- The difference between sale price and repurchase price is similar to interest.
- Repo markets are important for liquidity, dealer financing, and monetary policy implementation.
How a Repo Works
In a repo, one party sells a security to another party and agrees to repurchase it at a specified later date and price. The seller receives cash now and later returns cash plus the agreed price difference. The buyer receives the security as collateral and earns the implied return.
The transaction can be overnight or longer term. The details depend on the collateral, counterparty, margin or haircut, rate, maturity, and legal agreement.
Repo Versus Reverse Repo
Perspective | What it means |
|---|---|
Repo | Selling securities for cash and agreeing to repurchase them |
Reverse repo | Buying securities and agreeing to sell them back later |
Collateral | The securities supporting the cash transaction |
The same transaction can be called a repo by one party and a reverse repo by the other. The label depends on which side of the trade you are viewing.
Why Repo Markets Matter
Repo markets help financial institutions finance securities inventories, manage short-term cash, and support liquidity in government securities markets. Central banks also use repo and reverse repo operations as part of monetary policy implementation.
Stress in repo markets can matter because short-term funding markets affect banks, broker-dealers, money market funds, Treasury markets, and broader financial conditions.
Risks in Repo Transactions
Repos are collateralized, but they are not risk-free. Risks can include counterparty default, collateral price changes, operational problems, liquidity pressure, and legal disputes about collateral rights. Haircuts and margining are designed to help manage those risks.
The Bottom Line
A repurchase agreement is a short-term financing transaction that works like secured borrowing through the sale and later repurchase of securities. Repo markets are important because they help move cash and collateral through the financial system.