Repurchase Agreement

Published Jan 8, 2023

Definition of Repurchase Agreement

A repurchase agreement (Repo) is a financial transaction in which one party agrees to sell a security to another party and then repurchase it at a later date, usually for a slightly higher price. That means it is essentially a short-term loan that is secured by the collateral of the security.

Example

To illustrate this, let’s look at an example. Assume a bank needs to raise some short-term funds to cover its liquidity needs. To do this, it enters into a repurchase agreement with an investor. The bank agrees to sell a security (e.g., a bond) to the investor for a certain price and agrees to repurchase it at a later date for a slightly higher price. The difference between the two prices is the effective interest rate of the loan.

In this case, the investor provides the bank with a short-term loan and receives the security as collateral. The bank, on the other hand, receives the funds it needs and pays the investor a higher price for the security at the end of the agreement.

Why Repurchase Agreements Matter

Repurchase agreements are an important source of short-term funding for banks and other financial institutions. They are often used to cover liquidity needs or to finance the purchase of securities. In addition to that, they are also used by central banks to influence the money supply and interest rates. Thus, repurchase agreements are an important tool for banks and central banks alike.