A repurchase agreement, commonly referred to as a repo, is a financial transaction where one party sells an asset to another party with a promise to buy it back at a later date at a slightly higher price. The difference between the selling price and the repurchase price is the interest earned by the buyer. Repos are commonly used by banks, broker-dealers, and other financial institutions to obtain short-term funding.
If you are studying finance or working in the finance industry, you may come across the term “repurchase agreement” on your quizlet flashcards. This article will help you understand what a repurchase agreement is and how it works.
Repurchase agreements are typically used to obtain short-term funding, usually for overnight or a few days. The buyer of the asset, usually a bank or broker-dealer, provides cash to the seller, who typically pledges U.S. Treasury securities or other high-quality assets as collateral. The buyer holds the collateral until the seller repurchases the asset at the agreed-upon price, usually with a small interest payment for the buyer.
Repos are often used by financial institutions to manage their cash and liquidity needs. For example, a bank may need short-term funding to meet its daily cash requirements, such as paying its depositors or settling securities transactions. By entering into a repo agreement, the bank can obtain cash quickly while retaining the ability to repurchase the asset at a later date, often the next day.
Another common use of repos is in the trading of U.S. Treasury securities. Banks and broker-dealers often use repos to finance their position in Treasury securities, allowing them to earn a small profit from the difference between the repo rate and the yield of the securities.
In summary, a repurchase agreement, or repo, is a financial transaction where one party sells an asset to another party with a promise to buy it back at a later date at a slightly higher price. Repos are commonly used by banks, broker-dealers, and other financial institutions to obtain short-term funding and manage their cash and liquidity needs. Understanding repos is an important part of financial literacy and is often tested in finance exams, including on quizlet flashcards.