A repurchase agreement which is also generally termed as Repo is basically a short term loan for the dealers of the governed securities. This short term borrowing is used in the money market. Here the one who is selling the security agrees upon buying the government security back at a particular time and at a specific price. Thus here the seller is paying an interest rate which is called the repo rate at the time when the securities are being bought back. Generally, the repo’s are used for the purpose of raising the short term capital.
Now here one thing that is to be noted is that when the security is sold out on an agreement where it will be repurchased in future, there it is called as the repo rate. While on the other hand the party that is on the other end of the whole transaction process buys the security while also making an agreement that they will be selling it back in the future, then in this case it is called a reverse repurchase agreement.
Understanding the concept of RePo
In general the RePo is considered quite a safe investment the sole reason being that the security which is in function acts as collateral. Now these repurchase rates can take place between many different types of parties. When the repo takes place both the parties have to make sure that the funding is secured and that the liquidity is met. During the whole process of transaction, the seller will be acting as the short term borrower while the buyer acts as the short term lender. Here the security which is being sold is basically the collateral. These types of agreement are strictly a short term type of investments. The maturity period of these agreements are called the ‘rate’ or sometimes it is also referred to as the ‘tenor’.
Now even though there is a lot of similarity to the collateralized loans, repo’s are generally the purchases. Here the buyers of the security have ownership on it for a temporary period of time. As a result, these types of ownership are used as the loans for tax and sometimes for the purpose of accounting. Now if there is a case of bankruptcy, the investors of the repo are allowed to sell their collaterals which are not applicable in the case of the collateralized loans.
What is the significance of the repo?
At the time when the government makes a repurchase of the securities from the private banks then it is done at a rate which is discounted. This discounted rate is called the repo rate which is generally set by the central banks of the different nations. The significance of the repo rate is that it allows one to take control of the money supply within the economic system of a particular nation by simply increasing or decreasing the funds which are available.
In this way the repurchase agreement plays a crucial role and is vital for the economies to sustain in the fluctuating financial market.