Term Repurchase Agreement

What Is a Term Repurchase Agreement?

Under a term repurchase agreement (term repo), a bank will consent to buy securities from a dealer and afterward resell them back to the dealer a short time later at a pre-determined price. The difference between the re-buy and sale prices addresses the implicit interest paid for the agreement.

Term repurchase agreements are utilized as a short-term financing solution or cash-venture alternative with a fixed term enduring from overnight to half a month to several months.

How a Term Repurchase Agreement Works

The repurchase, or repo, market is where fixed income securities are bought and sold. Borrowers and lenders go into repurchase agreements where cash is traded for debt issues to raise short-term capital.

A repurchase agreement is a sale of securities for cash with a commitment to buy back the securities on a future date at a predetermined cost — this is the perspective on the borrowing party. A lender, for example, a bank, will enter a repo agreement to buy the fixed income securities from a borrowing counterparty, like a dealer, with a guarantee to sell the securities back inside a short period of time. Toward the finish of the agreement term, the borrower repays the money plus interest at a repo rate to the lender and reclaims the securities.

A repo can be either overnight or a term repo. An overnight repo is an agreement where the duration of the loan is one day. Term repurchase agreements, then again, can be up to one year with a majority of term repos having a duration of 90 days or less. Nonetheless, it isn't unusual to consider term repos with a maturity to be long as two years.

Benefits of a Term Repurchase Agreement

Banks and different savings institutions that are holding excess cash frequently utilize these instruments, since they have shorter maturities than certificates of deposit (CDs). Term repurchase agreements likewise will generally pay higher interest than overnight repurchase agreements since they carry greater interest-rate risk since their maturity is greater than one day. Moreover, the collateral risk is higher for term repos than overnight repos since the value of the assets utilized as collateral has a higher chance of declining in value over a longer period of time.

Central endlessly banks go into term repurchase agreements to empower banks to support their capital reserves. Sometime in the future, the central bank would sell back the Treasury bill or government soft cover to the commercial bank.

By buying these securities, the central bank assists with supporting the supply of money in the economy, in this manner, empowering spending and lessening the cost of borrowing. At the point when the central bank believes the growth of the economy should contract, it sells the government securities first and afterward buys them back at a settled upon date. In this case, the agreement is alluded to as a reverse term repurchase agreement.

Requirements for a Term Repurchase Agreement

The financial institution that purchases the security can't sell them to another party, except if the seller defaults on its obligation to repurchase the security. The security engaged with the transaction acts as collateral for the buyer until the seller can pay the buyer back. In effect, the sale of a security isn't viewed as a real sale, however a collateralized loan which is secured by an asset.

The repo rate is the cost of buying back the securities from the seller or lender. The rate is a simple interest rate that utilizes a genuine/360 calendar and addresses the cost of borrowing in the repo market. For example, a seller or borrower might need to pay a 10% higher price at repurchase time.

Features

• The borrower repays the money and the interest at the repo rate toward the finish of the term.
• Term repurchase agreements are utilized by banks (for example lenders) to buy securities and afterward resell them later at a settled upon price.
• These repo agreements, which can be overnight or a term of half a month or months, are utilized to raise short-term capital.