Repurchase Agreement (Repo)

What is a repurchase agreement (repo loan)?

A repurchase agreement, otherwise called a repo loan, is an instrument for raising short-term funds. With a repurchase agreement, financial institutions basically sell securities from another person, typically a government, in an overnight transaction and consent to buy them back at a higher price at later date. The security acts as collateral for the buyer until the seller can pay the buyer back, and the buyer acquires interest in return.

More profound definition

Repurchase agreements permit the sale of a security to one more party with the commitment that it'll be purchased some other time at a higher price. The buyer additionally procures interest.
With a repurchase agreement being a sell/buy-back type of loan, the seller acts as the borrower and the buyer as the lender. The collateral alludes to the securities sold, which for the most part begin with the government. Repo loans give quick liquidity.
The assets are intended to be sold right away, not at all like a secured deposit. In spite of the fact that repo loans are safe since they're backed by government securities, there is a risk that the securities will drop in value, harming the buyer's investment.
With an overnight repo loan, the agreed duration of the loan is one day. Be that as it may, either party can broaden the maturity period, and incidentally the agreement has no maturity date by any stretch of the imagination.
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Repurchase agreement model

Financial Services Inc., an investment bank, needs to raise a cash to cover its operations. It partners with Cash 'n' Capital Bank to purchase $1 million of U.S. Treasury bonds, with Cash 'n' Capital paying $900,000 and Financial Services Inc. getting the $1 million in bonds. When the repo loan develops, Cash gets $1 million plus interest, and Financial claims securities worth $1 million.

Features

• Repos and reverse repos are in this way utilized for short-term borrowing and lending, frequently with a tenor of overnight to 48 hours.
• A repurchase agreement, or 'repo', is a short-term agreement to sell securities to buy them back at a marginally higher price.
• The implicit interest rate on these agreements is known as the repo rate, a proxy for the overnight risk-free rate.
• The one selling the repo is really borrowing and the other party is lending, since the lender is credited the implicit interest in the difference in prices from commencement to repurchase.