Repo Definition

Search foreclosures by state: Click on the state to find foreclosures!

A repo or more broadly, a repurchase agreement, is normally a contract through which a seller of securities promises to buy them back at a later date for a mutually agreed price. Overnight repo, term repo, reverse repo, purchase agreement, buyback, and leaseback are some of the other related terms used in these kinds of operations.

Financial instruments like treasury or government bills, treasury/government or corporate bonds, and stocks/shares are offered as securities in a repurchase agreement. Typically, in this agreement, a prospective seller submits the instruments for cash, with a promise to repurchase them from the buyer at a specified time. The sum being repaid is always greater than the sum received at the time of agreement. The difference amount is termed as repo rate.

A repo differs marginally from a loan transaction. While taking a loan, the debtor places the instruments under a lien to the lender. Physical possession of the securities lies with the lender during the tenancy of the loan. When the loan is fully settled, the borrower gets back the ownership of the securities. If the debtor fails to clear the loan, the lender can dispose of the securities to recover the dues. If the sale value of the securities is lesser than the total loan amount, the creditor holds the legal right to recover the balance amount from the debtor.

In the case of a repo, the cash provider can liquidate the securities if the seller defaults in the repurchase of the instruments. However, the repo buyer cannot recover the full amount, if the sale value of the securities is lesser than the cash lent originally. This can happen if the instruments had depreciated in value during the repo agreement period. On the other hand, if the securities had appreciated during that period, the buyer stands to make a fair profit. Thus, a repo transaction carries a definite element of risk. Normally, repos are invariably overcollateralized to reduce the amount of risk involved. Daily market-to-market margining is also resorted to in repo agreements.

Persons trading in repos also act as market makers. These matched-book traders employ strategies of dealing in both repo and reverse repo transactions at the same time. They utilize the bid/ask spread that would normally be there between the reverse repo and repo rates to make profits. However, if different parties had transacted the same instruments in a chain operation, the failure of one party can put all the parties involved in the repo transaction to considerable risk. It can even spell ruin for all the concerned parties, particularly if the repo transaction is for a very high value. Such a situation arose when Refco, a New York-based financial services company, collapsed in October 2005.