Repo Financing

Repo financing, short for repurchase agreement financing, is a type of short-term borrowing in which one party, typically a financial institution such as a bank or a brokerage firm, sells securities to another party with an agreement to repurchase those securities at a later date.

Here's how it typically works:

• Agreement: The party selling the securities (the "seller" or "borrower") agrees to repurchase them at a later date, usually at a slightly higher price (which implies an interest rate) than the initial sale price.

• Securities Used: The securities involved in repo financing are often highly liquid assets such as government bonds, treasury bills, or corporate bonds.

• Term: Repo agreements can be very short-term, sometimes lasting only overnight (overnight repo), or they can extend for several weeks or months.

• Collateral: The securities sold in a repo agreement serve as collateral for the cash loan provided by the other party (the "buyer" or "lender"). If the borrower fails to repurchase the securities as agreed, the lender can sell the collateral to recover their funds.

• Interest Rate: The difference between the initial sale price and the repurchase price effectively represents the interest paid on the cash loan. This interest rate is called the repo rate.

Repo financing serves several purposes:

• Short-term Funding: It provides a source of short-term liquidity for financial institutions.

• Collateralized Borrowing: It allows institutions to borrow funds while providing high-quality collateral, which can lower the cost of borrowing compared to unsecured loans.

• Cash Management: It allows institutions to manage their cash positions efficiently by temporarily converting securities into cash and then repurchasing them when needed.

Repo financing is widely used in financial markets by banks, hedge funds, and other financial institutions to manage their liquidity and meet short-term funding needs. It also plays a crucial role in the functioning of money markets and the broader financial system.

See r*, Monetary Policy, LIBOR, SOFR, Swaps, and Repo.

See also Risk & Insurance.