Consumers concerned about their financial future can no longer stare at the news with glazed over eyes when they do not understand a term, they must take the time to explore and provide themselves with answers. One term that may help clarify the nightly news for you is learning the meaning of repurchase agreements.
So, what are repurchase agreements?
Repurchase agreements is a type of loan for those involved in investing in government securities. Repurchase agreements are a short-term borrowing maneuver utilized by a dealer of government securities. The securities are sold to investor, typically for twenty- four hours so they can borrow the money, but will purchase them back the following day. The seller of the investment calls the move a “repo” while the purchasing party calls it a “reverse repurchase agreement.”
Repurchase agreements are used to raise short term capital typically for money market investments. The economic effect of a repurchase agreement is a “secured loan,” where collateral is required in order for one to borrow money. In the case of a repurchase agreement the security that is switching hands between the seller then the buyer then back to the seller, is the collateral. Repo yields are quoted as interest rates like any other secured loan. However, the “interest” on the loan is composed of the discrepancy between the sale and repurchase prices paid for the security.
Why use repurchase agreements?
Repurchase agreements are not typically not used by the average investor it is more of a behind he scene strategy for security dealer to finance their securities inventories, There are customarily two reasons why a dealer would focus their energies on a repurchase agreement and they include
- short-term investment of funds (aka general collateral or GC)
- gain temporary use of a particular security (aka special security)
The pricing for a repurchase agreement is based on the normal rules of supply and demand that infiltrates the entire American financial system.