What Is a Repurchase Agreement?
A repurchase agreement is economically a secured loan structured as two trades. The borrower sells securities, most often U.S. Treasuries, to a cash lender and commits to repurchase them at a fixed price on a set date. The difference between the sale and repurchase prices implies an interest rate called the repo rate. From the cash lender's perspective, the same transaction is a reverse repo.
Most repos are overnight, though term repos run for weeks or months. Because the loan is backed by high-quality collateral and typically over-collateralized through a haircut of around 2%, repo rates sit near the very bottom of the interest rate spectrum. A $10 million overnight repo at a 5.00% rate costs the borrower about $1,389 in interest for a single night.
How the Repo Market Works
Securities dealers use repo to finance their bond inventories, borrowing cash against the positions they hold. Money market funds and other cash-rich investors supply the funding because repo offers a safe overnight home for cash with collateral protection. Much of the market clears through tri-party repo, where a custodian bank values the collateral and manages margin between the two sides.
The Federal Reserve is a major participant. It uses its standing repo facility to lend cash against Treasuries and its reverse repo facility to drain cash from the system, setting a corridor around its policy rate. SOFR, the benchmark that replaced LIBOR for U.S. dollar lending, is calculated from more than $1 trillion of daily Treasury repo transactions.
Why It Matters
Repo is the plumbing of modern finance. When it seizes up, as it did in September 2019 when overnight rates briefly spiked toward 10%, the Fed must intervene, and in 2008 the run on repo funding helped topple Bear Stearns and Lehman Brothers. Understanding repo therefore means understanding how leverage and liquidity actually flow through the financial system.
For candidates targeting fixed income sales and trading or bank treasury roles, repo mechanics come up constantly, because financing costs determine whether a bond position is profitable to carry. Hedge fund strategies such as the Treasury basis trade depend entirely on cheap repo leverage, which is why regulators monitor the market so closely.
