Repo and Reverse Repo Agreements

Overview

• Bank A needs cash quickly, owns bonds.
• Bank B has excess cash and wants to invest it.

Repo Agreement

• Definition: A repurchase agreement (repo) is a contract where Bank A (the dealer) sells bonds to Bank B and agrees to buy them back at a higher price later, typically the next day.

Process:

1. Bank A sells bonds to Bank B to obtain cash.
2. Bank B provides cash to Bank A.
3. Bank A repurchases the bonds at a higher price, returning the cash with interest.

Impact:

• Bank A receives the necessary cash.
• Bank B earns a profit from the transaction.

Reverse Repo Agreement

• From Bank B's perspective, this transaction is termed a reverse repo:
  • Definition: Buying securities (bonds) from Bank A with the intention of selling them back at a profit later.

Participants in Repo Transactions

• Repo transactions can involve various entities:
  • Banks
  • Mutual funds
  • Hedge funds
  • Central banks

Third Party Involvement

• Sometimes, a third-party repo occurs where a middleman facilitates the transaction between buyer and seller.

Comparison to Loans

• Repo agreements resemble loans with bonds as collateral.
• Key Difference: Collateral in a repo agreement changes hands, implying a temporary change of ownership.

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This summary outlines the mechanics of repo and reverse repo transactions, highlighting the roles of involved banks and the implications of these agreements.