Reverse Repurchase Agreement (Reverse Repo)
A reverse repurchase agreement, or “reverse repo”, is the purchase of securities with the agreement to sell them at a higher price at a specific future date. For the party selling the security (and agreeing to repurchase it in the future) it is a repurchase agreement(RP) or repo; for the party on the other end of the transaction (buying the security and agreeing to sell in the future) it is a reverse repurchase agreement (RRP) or reverse repo.
Repos are classified as a money-market instrument, and they are usually used to raise short-term capital.
Instead of outright sale of securities the central bank may sell the securities through an agreement which has a specification about the date and price at which it will be repurchased. This type of agreement is called a reverse repurchase agreement or reverse repo. The rate at which the money is withdrawn in this manner is called the reverse repo rate.
The Reserve Bank of India conducts repo and reverse repo operations at various maturities:overnight, 7-day, 14- day, etc. This type of operations have now become the main tool of monetary policy of the Reserve Bank of India.
- A reverse repo is a short-term agreement to purchase securities in order to sell them back at a slightly higher price.
- Repos and reverse repos are used for short-term borrowing and lending, often overnight.
- Central banks use reverse repos to add money to the money supply via open market operations.
Triparty RRPs
Part of the business of repos and RRPs is growing, as third-party collateral management operators are providing services to develop RRPs on behalf of investors and provide quick funding to businesses in need.
As quality collateral is sometimes difficult to find, businesses are taking advantage of these assets as a quality way to fund expansion and equipment acquisition through the use of triparty repos, resulting in RRP opportunities for investors. This section of the industry is known as collateral management optimization and efficiency.
Components of an RRPs
An RRP differs from buy/sell backs in a simple yet clear way. Buy/sell back agreements legally document each transaction separately, providing clear separation in each transaction. In this way, each transaction can legally stand on its own without the enforcement of the other. RRPs, on the other hand, have each phase of the agreement legally documented within the same contract and ensure the availability and right to each phase of the agreement. Lastly, in an RRP, although collateral is in essence purchased, generally the collateral never changes physical location or actual ownership. If the seller defaults against the buyer, the collateral would need to be physically transferred.
You may also like
UPSC Commerce Optional 2024 Question Paper – Download the PDF
Money multiplier