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Repurchase Agreements or REPOS

The term repo stands for sale and repurchase agreement and is similar to a secured loan.

One party agrees to sell securities, for example bonds or gilts, to the other and receives collateral in cash to secure the loan. At the same time the parties agree to repurchase an equivalent or equal securities at a specific price in the future. At that point the securities are returned to the borrower and the lender returns the collateral. The cost of this secured finance is given by the difference between the sale and repurchase priceo of these bonds and is known as a the repo rate.

A reverse repo is simply the same repurchase agreement from a buyers point viewpont, and not the sellers. In other words, the seller executing the transaction would describe it as a repo, while the buyer in the same transaction would describe it as a reverse repo. So repo and reverse repo are exactly the same kind of transaction, just described from opposite viewpoints.

The purpose of the repo market as implemented by central banks such as the bank of England and the European Central Bank, is to provide or take away liquidity from the money market. In a repo transaction there are two parties. The repo participant agrees to initially sell and then buyback instruments, the reverse repo participant is the other side of the transaction that agrees to initially buy and then sell the instruments at a later date.

The central bank will use these instruments to influence the money supply, it will enter into repo agreements as the reverse repo participant and with other money market institutions such as the banks being the repo participant. So therefore as the reverse participant the central bank will provide the collateral provided under the repo.

If the central bank wishes to drain liquidity from the money markets then it will use repo transactions. This time the central bank will be the repo player initially selling instruments and therefore withdrawing cash from the system.

A Tri-Party Repos

A Tri-party repo is a custodian bank or clearing bank or clearing organization that acts as an intermediary between two parties to the repurchase or repo agreement outlined above.