A repurchase agreement, also known as a repo, is a type of short-term borrowing where one party sells an asset, usually government securities, to another party with a promise to repurchase the same asset at a higher price at a later time. This type of transaction is used to raise short-term funding and manage cash reserves.
The party that sells the asset is known as the «seller,» while the party that buys the asset is known as the «buyer.» The seller agrees to repurchase the asset from the buyer at a later date, usually within a few days or weeks. The difference between the sale price and repurchase price is known as the «repo rate» and represents the interest rate on the loan.
Repo agreements are generally used by financial institutions such as banks, hedge funds, and mutual funds, as a way to obtain short-term funding. They are also used by governments to manage their short-term cash requirements.
There are two types of repo agreements: bilateral and tri-party. A bilateral repo involves only two parties, while a tri-party repo involves a third-party clearing agent who facilitates the transaction.
In a repo agreement, the seller retains ownership of the asset throughout the transaction, and the buyer holds the asset as collateral until the seller repurchases it. In the event that the seller fails to repurchase the asset, the buyer has the right to sell the asset to recover their funds.
In conclusion, a repurchase agreement is a short-term borrowing transaction where one party sells an asset to another party with a promise to repurchase it at a later date. The purpose of this type of transaction is to raise short-term funding and manage cash reserves. Repo agreements are commonly used by financial institutions and governments and can be either bilateral or tri-party.