What Is A Repurchase Agreement?
A repurchase agreement (also known as a repo) is an agreement in which the borrower loans security (which serves as collateral) to the lender in return for money, with the pledge to give it back at a predetermined future price. A repo deal does not result in the transfer of ownership of the securities.
Repurchase agreements are typically regarded as secure transactions because the security is serving as collateral and the majority of these agreements involve the US Treasury bonds.
A repo is a short-term, collateral-backed, interest-bearing transaction in which the buyer and seller operate as a short-term lender and borrower. In this form of trade, both parties are confident that the arrangement is favorable. One receives the funds required, and the other gets the security. This serves as a backup if the repayment agreement is not satisfied.
The two parties involved in the repo are:
The “selling” party: This party receives compensation for selling the security to the opposing party. This individual eventually buys back the exact security at a stipulated price at a later date.
The “buying” party: This party provides financial assistance to the opposing party to purchase the security. This individual eventually resells the exact security to the opposing party at a set price later.
In a repurchase agreement, the duration for the repurchase is referred to as tenor. There are two types of tenor, which are:
Fixed Repo Tenor, who has a definite start and end date. This type of tenor can be overnight, months, or years whereas there is no set start or finish date for Open Repo Tenor; it can be canceled on any working day in the future if both parties provide adequate notification.
Repurchase Agreement Example
For example, Albert, a trader, sells specific security for $250,000 to another trader, and they both agree on a specified sum for Albert to buy the security later. The trader keeps the security in case Albert fails and does not repurchase. Albert paid $300,000 to repurchase the security he sold, with the $50,000 serving as an interest payment to the trader.« Back to Glossary Index