Repurchase Agreement (Repo)
A repurchase agreement (repo) is a form of short-term borrowing for dealers in government securities. In the case of a repo, a dealer sells government securities to investors , usually on an overnight basis, and buys them back the following day at a slightly higher price. That small difference in price is the implicit overnight interest rate. Repos are typically used to raise short-term capital. They are also a common tool of central bank open market operations.
A repurchase agreement, or ‘repo’, is a short-term agreement to sell securities in order to buy them back at a slightly higher price.
- The one selling the repo is effectively borrowing and the other party is lending, since the lender is credited the implicit interest in the difference in prices from initiation to repurchase.
- Repos and reverse repos are thus used for short-term borrowing and lending, often with a tenor of overnight to 48 hours.
- The implicit interest rate on these agreements is known as the repo rate, a proxy for the overnight risk-free rate.
There is another type of operation in which when the central bank buys
the security, this agreement of purchase also has specification about date and
price of resale of this security. This type of agreement is called a repurchase
agreement or repo. The interest rate at which the money is lent in this way is
called the repo rate.
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