Repurchase agreement also known as Repo in financial industry is an agreement between the repo seller to take a loan on the collateral security and to buy-back the collateral after a pre-specified duration or at a pre-specified date. In this agreement, the holder of the security (mainly government security, treasury bills, stocks, bonds, loans etc) makes an agreement to sell the security to a lender and to buy back the security at a later date. The lender earns on the amount of the difference between the buying price and selling price which is effectively named as the interest or coupon rate.
In this deal, the buyer holds the security as collateral and can sell the security if the seller is unable to repurchase the security at maturity. This collateralized security makes the repurchase transaction a secure transaction with lower credit risk.
Types of Repo:
Based on maturity, there are two types of Repo rates which are term and open repo. A term repo has a term date specified while open repo rate does not contain end date.
Repo transactions can also be classified based on their holding pattern as, which are specified, tri-party and held-in custody.
Reverse Repo: A reverse repo is the same repurchase agreement but the only difference is that it is from a buyer’s point of view. In this transaction, the buyer sells the security which it bought from other seller in the market. At the maturity of the original repo transaction, the buyer will purchase the security from the market and return it to the seller.
How repurchase agreement benefits both seller and buyer: