Introduction
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. For the length of the repurchase agreement, the seller pays the buyer an interest rate implied by the difference between the initial sale price and the repurchase price. It is an effective way to raise short-term capital.
Definition
A Repurchase Agreement (Repo; RP) is an agreement between a seller and a buyer, typically involving U.S. government securities. Under this agreement, the seller agrees to repurchase the securities at a predetermined price and usually at a specified future date. This arrangement is extensively used both as a money market investment vehicle and as an instrument by the Federal Reserve Board to execute monetary policy.
Examples
- Central Bank Operations:
- Central banks, such as the Federal Reserve, often engage in repos to manage the money supply and regulate short-term interest rates.
- Financial Institutions:
- Banks and other financial institutions use repos to manage liquidity and to finance inventories of securities.
- Corporate Use:
- Corporate treasuries may leverage repos to park excess cash in a low-risk investment, generating some return while maintaining liquidity.
Frequently Asked Questions (FAQs)
What is the purpose of a repurchase agreement?
A repurchase agreement is primarily used to raise short-term capital. It is a method for financial institutions, and sometimes other entities, to secure funds quickly and efficiently.
How does a repurchase agreement work?
In a repo, the seller sells securities to a buyer with an agreement to repurchase them at a later date at a predetermined price. The difference between the sale price and the repurchase price represents the interest.
What is the typical duration of a repurchase agreement?
Repurchase agreements typically range from overnight to 30 days, although longer-term agreements can occur.
Who participates in repurchase agreements?
Participants usually include central banks, commercial banks, investment banks, hedge funds, and other financial institutions.
How does a repo influence monetary policy?
Repos are used by central banks to control the money supply and influence short-term interest rates. By engaging in repos, central banks can inject liquidity into the banking system.
Related Terms
Money Market
A segment of the financial market in which financial instruments with high liquidity and short maturities are traded. It is used by participants as a means for borrowing and lending in the short term, usually for periods of a year or less.
Monetary Policy
The process by which a central bank, like the Federal Reserve, manages a nation’s money supply and interest rates to achieve macroeconomic goals such as controlling inflation, consumption, growth, and liquidity.
Online References
- Investopedia - Repurchase Agreement
- Federal Reserve Bank of New York - Repo and Reverse Repo Agreements
- Securities Industry and Financial Markets Association (SIFMA) - Repo Market
Suggested Books for Further Studies
- “Money Market Operations” by Susan Mills, focuses comprehensively on understanding money market instruments, including repurchase agreements.
- “Repurchase Agreements and the Law” by Jonathan Powell, discusses the legal framework and practical application of repos.
- “The Repo Handbook” by Moorad Choudhry, provides an in-depth analysis of the repo market and its mechanics and strategies.
Fundamentals of Repurchase Agreements: Finance Basics Quiz
Thank you for reviewing this overview of repurchase agreements and taking on the challenge of our interactive quiz. Continue to expand your finance knowledge with our suggested resources!
