What is a Repurchase Agreement

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Repurchase agreements or repo are short-term instruments with a maturity of generally not more than a year, sometimes only a few days or a night (overnight repo).

A repo in the view of the investment vendor is a financial transaction that involves a simultaneous sale and repurchase of an asset. These are genuine repurchase agreements, and in the course of the term of ownership by the seller, the property will subsequently be passed to the buyer.

A repo is equivalent to a secured loan, as the buyer obtains securities as collateral to safeguard against the possibility of default by the seller, who in principle is the borrower. In the euro zone, the repo was replaced in 1999 by the legal forms of refinancing of securities, and almost universally follows the framework agreement developed by ISMA.

Repurchase agreements are part of the money market and serve institutional investors, mainly banks to obtain liquidity in the interbank market and with central banks in the framework of open market operations.

The repo has all the appearances and characteristics of a cash sale followed by a redemption, except the accounting treatment and taxation, ignores the title operation.

There are two distinct segments of the repurchase agreement market, and the bulk market is regarded as a real money market, and is by far the most important of the two segments in terms of amounts. It brings increased safety compared to conventional interbank deposits,and is supplanting the traditional money market as its share in the amounts processed increase annually.

Nearly all securities can be utilized in a repo, although highly liquid securities are favored since they are much easier to put away in case of a default. In addition, they it is simple to secure the securities in the open market on which a buyer initiated a short position in the repo security via a reverse repo and market sale.

However, in contrast to  a secured loan, legal title to the securities is passed between the seller and the buyer. To ensure greater security of transactions in addition to any discount applied, securities are revalued periodically, and cash margin calls can adjust the amount actually paid according to market fluctuations.

Any coupons falling within the repo remain property of the borrower of securities, and should therefore be taken into account in calculating the flow of operation.

The repurchase price is calculated from the agreed purchase price plus interest, which is dependent on the quality of the security. To protect themselves against price declines of the bond, payment is made on the purchase of a security.

 

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