The sale or the repurchase agreement is known as repo. It is a kind of repurchase agreement that stands for the selling of securities along with an agreement according to which the individual selling is authorized to purchase the securities back at another date. In this case the individual selling becomes a borrower and the individual purchasing acts as the lender. The securities that are exchanged in this case are considered as the collateral for the loan. The cash that is received out of the sale is referred to as the loan amount. At any time in the coming period in future the seller has the right to claim back the securities by buying them at a rate higher than the actual selling price.
Repo is similar to a cash transaction, except that it is with a forward contract. Exchange money in return of legal transfer for the securities is the cash transaction. By this way the money or the amount of loan is received by the borrower and we can also say he gets what he wants and the lender gets what he wants which means the transfer of the collateral securities. The repurchase agreement ensures the guarantees. And the guarantee is that after the maturity period at the settlement date mentioned in the agreement the lender will get back the money and the borrower will get back his security.
In a repo, it can be said that any security may be effectively employed. Repo can be equated to a secured loan. Mostly or Many times preference is given to highly liquid securities, if we look practically. In the event of default, it is much easier to dispose them off. The significant point of this is it is easy to secure them in the open market. Open market i the market where the buyer has created a short position in the repo security by way of a reverse repo and market sale; by the same notion, illiquid securities are discouraged.
The repurchase and the sale agreement guarantees and assures that the borrower would get back his securities and the lender will get his money back once the maturity date written in the contract arrives. Repo is similar to a secured loan. One can say that almost all kinds of securities will be efficiently used in case of a repo although most of the times people prefer securities that are extremely liquid as they are comparatively more simple to attain and are also simple to dispose when we talk of an open market where generally the buyer with the help of market sale and reverse repo creates a short spot in case of repo security. In the same manner the transaction of securities that are not liquid is highly discouraged.
A reverse repo is nothing different from what was discussed above as it is nothing but the same agreement from the buyer’s (or the lender’s) point of view. What the seller will describe as repo rate ( the interest rate of the loan) is the same that the buyer will describe as a reverse repo rate. The term “reverse repo and sale” is most commonly used to describe the creation of a short term position in a debt instrument (loan) where the buyer(or the lender) in the repo transaction immediately sells the security procured from the seller in the open market and then procures it back from there after the maturity period has lapsed – on the settlement date prescribed according to repo agreement.
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