Repurchase agreement

A sale (and) repurchase agreement, also known as a (currency) repo, RP, or sale and repurchase agreement, is a transaction concluded on a deal date t_D between two parties A and B:

(i) A will on the near date t_N sell a specified security S at an agreed price P_N to B

(ii) A will on the far date t_F (after t_N) re-purchase S from B at a price P_F which is already pre-agreed on the deal date.

If we assume positive interest rates, the repurchase price P_F can be expected to be greater than the original sale price P_N.

The (time-adjusted) difference (P_F-P_N)/P_N*(t_F-t_N)/365 is called the repo rate; it can be interpreted as the interest rate for the period between near date and far date.

Ambiguity in the usage of the term repo

The term repo has given rise to a lot of misunderstanding: there are two types of transactions with identical cash flows

(i) a sell-and-buy-back as well as

(ii) a collateralized borrowing.

The sole difference is that in (i) the asset is sold (and later re-purchased), whereas in (ii) the asset is instead pledged as a collateral for a loan: in the sell-and-buy-back transaction the ownership and possession of S are transferred at t_N from a A to B and in t_F transferred back from B to A; conversely, in the repo only the possession is temporarily transferred to B whereas the ownership remains with A.