Repurchase agreement
The sale of a security combined with an agreement to buy it back at a set price and date — legally a sale, economically a loan secured by collateral.
Also called: repo, reverse repo, sale and repurchase.
Repo is the plumbing of modern finance. Dealers fund their inventory in it, money funds park cash in it, and it is how Treasuries are turned into cash without being sold outright.
The legal form matters enormously in a default. Because it is a sale rather than a pledge, the cash lender can seize and sell the collateral immediately rather than queuing in bankruptcy — which is what makes lenders willing to fund at very fine spreads.
The same trade has two names depending on where you stand. The cash borrower is doing a repo; the cash lender is doing a reverse repo. The Fed's ON RRP facility is named from the Fed's side.
The mechanics
- Cash borrower
- Delivers collateral, receives cash, agrees to repurchase — usually overnight.
- Haircut
- The collateral is worth slightly more than the cash, protecting the lender from price moves.
- Re-use
- Collateral can be pledged onward, so one bond can support several chains of credit.
The common misreading
That repo is a niche technicality. It is the market where the price of overnight money is actually set, and every major post-1990 funding crisis has run through it.
Related terms
- Secured Overnight Financing RateA broad measure of the cost of borrowing cash overnight secured by US Treasury collateral, published each morning by the New York Fed and the main US replacement for LIBOR.
- Overnight Reverse Repurchase Agreement FacilityA Federal Reserve facility where eligible non-banks lend cash to the Fed overnight against Treasury collateral, putting a hard floor under short-term interest rates.
- EurodollarA US dollar deposit held at a bank outside United States jurisdiction — dollars created offshore, beyond the Federal Reserve's direct reach.
- Primary dealerA trading counterparty of the New York Fed, obliged to bid at every Treasury auction and to make markets in government securities — the channel through which open market operations reach the financial system.
Primary sources
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