A REPO, short for repurchase agreement, is a financial contract commonly used in the banking and financial sectors. It is a short-term borrowing mechanism and a form of secured lending. In a typical repo transaction, one party, usually a financial institution or a central bank, temporarily sells a security (such as government bonds or Treasury bills) to another party, with the agreement to repurchase it at a predetermined date and price.
The party selling the security is referred to as the "seller" or "borrower," while the party buying the security is called the "buyer" or "lender." The seller pledges the security as collateral for the cash received, while the buyer lends the cash and receives the security. The interest rate charged is known as the "repo rate."
Repos are popular due to their flexibility and liquidity benefits. They allow institutions to raise short-term funds quickly, often overnight, by using highly liquid securities as collateral. Repurchase agreements are widely used in central bank open market operations to manage the money supply and implement monetary policy.
The risk associated with repos is generally considered low since they involve high-quality collateral. However, as with any investment, there is always a degree of risk involved, particularly default risk. In the event the seller fails to repurchase the security, the buyer can sell the collateral to recover the funds lent.
