What is a repurchase agreement (repo) transaction?

What is a repurchase agreement (repo) transaction?

• A. A sale of a security with an agreement to repurchase it later.
• B. A loan secured by stocks with no collateral.
• C. A forward contract for currency exchange.
• D. A derivative based on interest rates.

Answer: (A)

A repurchase agreement is a short-term financing arrangement where a security is sold today with an agreement to buy it back later at a higher price. The buyer of the security provides cash and holds the securities as collateral, while the seller receives cash now and commits to repurchase the securities on a specified date. The difference between the sale price and the repurchase price represents interest on the loan, so the deal functions as a collateralized, short-term loan rather than a simple sale. This mechanism is widely used by banks for quick funding and by central banks in monetary operations. The description described here distinguishes it from other instruments: a loan with no collateral isn’t consistent with the collateralized nature of repos, a forward currency contract locks in an exchange rate rather than involves selling and repurchasing a security, and a derivative based on interest rates is a separate class of financial instrument.

A repurchase agreement is a short-term financing arrangement where a security is sold today with an agreement to buy it back later at a higher price. The buyer of the security provides cash and holds the securities as collateral, while the seller receives cash now and commits to repurchase the securities on a specified date. The difference between the sale price and the repurchase price represents interest on the loan, so the deal functions as a collateralized, short-term loan rather than a simple sale. This mechanism is widely used by banks for quick funding and by central banks in monetary operations. The description described here distinguishes it from other instruments: a loan with no collateral isn’t consistent with the collateralized nature of repos, a forward currency contract locks in an exchange rate rather than involves selling and repurchasing a security, and a derivative based on interest rates is a separate class of financial instrument.