What are Repurchase Agreements
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Repurchase Agreements are Also Known as Repos, Reverses, Sale-Repurchase Agreements and RPs
Let's say your some major institution and you need some short-term cash right away. You own a lot of securities, such as stocks and bonds. You could raise the cash by selling them, but you don't really want to. You like them. You want to keep them. You don't want to pay capital gains.
So you use them as a form of collateral for a short-term loan.
You find another institution or a dealer who agrees to loan you the money you want by "buying" some of your securities (usually Treasury bills). However, at the end of the loan's term, they will "sell" the securities back to you -- when you pay off the loan. The contract between you and the dealer is the sale-repurchase agreement or repo.
Repos are Tracked by the Government Securities Division of the Fixed Income Clearing House Corporation (FICC)
Also, most work under the terms of a master repo agreement.
One side of the transaction lends money -- they speak of reversing in securities.
The other side of the transaction receives the money -- they speak of reversing out securities.
This Master Repo Agreement is Treated as a Collateralized Loan
Does the government object? The Federal Reserves is very active as a major player in the repo market. The Fed uses these transactions to pump liquidity into or our of the system. They're a major part of the Fed's open market transactions to adjust the economy.
Repos are a huge market. In 2006, on average $5.67 trillion was the average in outstanding repos.
The Repo Rate is Quoted as the Interest Rate Paid on the Loan
Usually, the party receiving the money must give collateral worth slightly more than the money received. This is known as a "haircut" and is usually 1-3%, but can be higher if their credit rating is low.
Some parties take out open repos -- where there's a continuous contract. However, most terms are from 1- 30 days, many overnight.
Sometimes the contract allows for a right of substitution, where the collateral returned to the borrower is not exactly the same as that given. Both sides take on some interest rate risk. If it goes down, it's in the chutes.
A General Collateral Finance (GCF), Forward Repos, Overnight Repos, Term Repos, Letter Repos or Hold-in-Custody (HIC) are Other Types
Many repos now are tri-party. That is the custodian of the securities is also involved in the transaction.
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