Repo

A repo, short for repurchase agreement, is a short-term borrowing arrangement commonly used in the money markets to manage liquidity and collateral. In a typical repo transaction, one party sells securities (usually government bonds) to another party with a simultaneous agreement to repurchase those same securities at a later date, often overnight or within a few days, at a slightly higher price. The difference in price functions as an implied interest rate, known as the repo rate.

Repos are widely used by financial institutions, central banks, and large investors to fund short-term needs or to invest excess cash. For the seller (the borrower), the repo acts like a secured loan, with the securities serving as collateral. For the buyer (the lender), it is a low-risk investment, as the transaction is backed by high-quality assets and includes a repurchase agreement to ensure return of funds. If the borrower defaults, the lender retains the securities to mitigate potential losses.

Repos play a crucial role in maintaining liquidity and stability in the financial system. Central banks, such as the U.S. Federal Reserve, use repos as a monetary policy tool to inject or absorb liquidity in the banking system. For example, in an overnight repo, the Fed might buy Treasury securities from banks and agree to sell them back the next day, temporarily increasing reserves in the system. The repo market is a cornerstone of short-term funding, especially for institutions needing quick access to cash while holding large portfolios of fixed-income securities.

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