The Most Comprehensive Financial Dictionary with over 1000 Financial Terms Explained - Clear and Concise Article Style Description with Practical Examples

What are Repurchase Agreements?

2017-03-11T08:23:18+00:00

The term 'Repurchase Agreements' is included in the Banking edition of the Financial Dictionary. It's available on mazon in Kindle or Paperback version. See more details here.

Repurchase agreements refer to types of short term time borrowing. It is the government securities dealers who engage in them. The appropriate dealer will first sell such government securities to institutional investors or financial institution investors. They usually do this for overnight. After this, they will purchase them back the next day.

Those parties who sell the security and agree to subsequently buy it back in the near future are involved in such a transaction as a repo. The opposite end of the transaction parties who buy the security and consent to sell it back in the near future are engaging in a reverse repurchase agreement.

Economists and analysts consider repurchase agreements to be money market instruments. They are typically utilized to raise shorter time frame capital. In these arrangements, the buyer functions as the short term time frame lender. The seller carries on like the shorter term borrower. The collateral is the security itself. In this way, both entities involved in the transaction meet their goals to secure liquidity and funding.

Repurchase agreements typically rank as safe forms of investments. This is because the security being traded is also collateral. It also helps to explain why the majority of such agreements have Treasury bonds as their security. Besides this, the United States Federal Reserve uses these types of agreements themselves. They deploy them to control the amount of bank reserves and the overall money supply. Individual investors like these agreements for financing debt security purchases. In any case, the repurchase agreement is always and only a shorter term investment. The term or rate refers to the maturity period of the repo in question.

Even though they are many similarities between these agreements and interest paying loans which are short term in nature, repurchase agreements are different. They represent true purchases. Yet the buyers keep such instruments only temporarily. This is why both accounting and taxing authorities treat them as loans. Those agreements which specify their maturity date represent term agreements. In the majority of cases, these agreements will reach maturity either the next week or alternatively the following day.

Other Repurchase agreements are open ones. This is because they do not have a maturity date specified by and in the contract. It means the sellers or buyers can complete the terms of the agreement and then renew them or instead choose to terminate them. Almost all such open arrangements will wind down in from one to two years.

Three different kinds of repurchase agreements exist. The first is called a specialized delivery repo. These financial transactions mandate that the agreements and maturities must have a guarantee of bonds. Such an agreement is uncommon.

There are also the held in custody repos. With these, sellers get cash for the security sale. They still keep it within a custody account on behalf of the purchaser. Such an arrangement is still less common than the specialized delivery repos. This is because there is a chance that the seller could declare bankruptcy, leaving the borrower unable to access the collateral as a result.

The most common kind of repurchase agreement is the third party repo agreement. Such arrangements involve either banks or clearing agents which act as intermediaries of the transaction between sellers and buyers. They safeguard each party’s interest this way. By taking possession of the securities involved, they make certain that the seller will obtain cash when the agreement commences and the purchaser will transfer over the funds for the seller and also make delivery of the securities when maturity occurs. Such arrangements as these make up more than 90 percent of the total repo market. In 2016, this market contained around $1.8 trillion.

The term 'Repurchase Agreements' is included in the Banking edition of the Financial Dictionary. You can get your copy on mazon in Kindle or Paperback version. See more details here.