Legal Definitions - repurchase agreement

A repurchase agreement, often shortened to repo, is a financial transaction where one party sells a security (such as a bond or stock) to another party with a simultaneous agreement to buy it back at a later date for a slightly higher, predetermined price. Essentially, it functions as a short-term, collateralized loan. The party selling the security receives cash immediately, using the security as collateral, and the party buying the security gets a return on their temporary investment when the security is repurchased.

• Example 1: Bank Liquidity Management

  A large commercial bank, "Horizon Bank," needs to quickly raise $100 million for a single day to meet its regulatory reserve requirements. Instead of borrowing directly, Horizon Bank sells $100 million worth of U.S. Treasury bills to "Capital Trust," another financial institution, with an agreement to repurchase those exact Treasury bills the very next day for $100,010,000.

  How it illustrates: Horizon Bank (the seller) effectively obtains a short-term loan of $100 million from Capital Trust. The U.S. Treasury bills serve as the security or collateral for this loan. Horizon Bank promises to buy back (repurchase) the securities on a specified date (the next day) at a specified price ($100,010,000), which includes the original loan amount plus a small amount of interest.

• Example 2: Corporate Treasury Operations

  A multinational technology company, "Innovate Corp.," has a large amount of cash in its treasury department that it wants to invest overnight to earn a small, low-risk return, but it needs the funds readily available for a major acquisition payment the following morning. Innovate Corp. enters into a repurchase agreement where it "buys" government bonds from a securities dealer, with the understanding that the dealer will buy them back the next day at a slightly higher price.

  How it illustrates: In this scenario, Innovate Corp. is the "buyer" in the repo transaction. It provides a short-term loan to the securities dealer, receiving government bonds as collateral. The dealer agrees to repurchase the bonds the next day at a specified price, allowing Innovate Corp. to earn a low-risk, short-term return on its excess cash while ensuring the principal funds are available precisely when needed.

• Example 3: Investment Firm Funding

  An investment firm, "Global Assets Management," holds a significant portfolio of high-grade corporate bonds. To take advantage of a sudden, lucrative short-term trading opportunity that requires immediate cash, Global Assets Management enters into a repurchase agreement. It sells a portion of its corporate bonds to a money market fund for a week, agreeing to buy them back at the end of the week for a slightly higher, pre-agreed price.

  How it illustrates: Global Assets Management uses its corporate bonds as collateral to secure a short-term cash infusion (a loan) from the money market fund. The firm commits to repurchasing the bonds on a specific future date at a pre-agreed price, allowing it to access liquidity for its trading strategy without having to permanently sell its long-term bond holdings.