A repurchase agreement (repo) is a type of short-term financing for government securities dealers. A repo occurs when a dealer sells government securities to investors overnight and then buys them back the next day at a slightly higher price. The implied overnight interest rate is that little price difference. Short-term capital is generally raised through repos. They’re also a frequent instrument used by central banks to conduct open market activities.
It is a repo for the party selling the security and promising to repurchase it in the future; it is a reverse repurchase agreement for the party on the other end of the transaction, purchasing the security and agreeing to sell it in the future.
Types of Repo
A third-party repository is the most frequent type (also known as a tri-party repo). A clearing agency or bank executes the transactions between the buyer and seller and protects each party’s interests in this arrangement. It keeps the securities and guarantees that the seller is paid in cash at the start of the agreement, that the buyer transfers funds to the seller’s advantage, and that the securities are delivered upon maturity.
A bond guarantee is required at the start of the arrangement and again at maturity in a specialised delivery repo. This sort of arrangement is uncommon.
The seller receives cash for the sale of the security in a held-in-custody repo, but the money is held in a custodial account for the buyer. Because there is a danger that the seller would go bankrupt and the borrower will lose access to the collateral, this form of arrangement is even less prevalent.