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Information > Financial Terms > This page Repurchase Agreements Two
simultaneous transactions in which a holder of securities sells securities
to an investor with an agreement to repurchase them at a fixed price on
a fixed date. A reverse repo
is the same transaction from the perspective of the lender.
The security buyer in effect lends the seller money for the period
of the agreement, and the terms of the agreement are structured to compensate
the buyer for this. Dealers
use repurchase agreements (repos) to finance their positions.
In effect, a repo is a short-term, collateralized loan from an
investor to a dealer. The
Federal Reserve uses repos to supply reserves to the banking system and
reverse repos to drain its reserves. Repurchase
agreements can be done on an overnight basis, for a fixed term, or on
the basis of a continuing contract.
Fixed-term repos are usually made for less than 30 days.
When executed under a continuing contract, repo contracts usually
contain a clause to adjust the interest rate on a day-to-day basis.
Interest rates on overnight repurchase agreements usually are lower
than the federal funds rate by as much as 25 basis points.
The additional security provided by the loan collateral employed
with repos lessens their risk relative to federal funds.
Repos are usually negotiated in large dollar amounts. The
use of repos became common after World War II among a few government security
dealers and large money center banks.
Since the 1960s, the volume of transactions and the number of participants
have grown substantially. In
1985, the annual average volume of dealers amounted to $320 billion.
Repos have proved to be very popular cash management vehicles for
individuals, firms, and governments with unpredictable cash flows.
Repos have been associated in recent years with widely publicized
scandals involving the failure of government security dealers.
A publication of the Federal Reserve Bank of Atlanta concluded
that losses to investors can be avoided if investors (1) operate under
the terms of a clearly specified and executed master repurchase agreement,
(2) properly assess counterparties including their corporate structure
and capital strength, (3) use appropriate procedures for obtaining control
of securities, and (4) evaluate securities appropriately and monitor them
regularly, making margin calls when necessary. Repurchase
agreements have two major applications. 1. Bonds are sometimes sold by one bank or investment house to another with the privilege of repurchase. This transaction is tantamount to securing a loan equal to 100% of the collateral offered. For instance, should an investment house desire to borrow funds with bonds as collateral, it may, instead of applying for a loan, arrange to temporarily sell them to a bank with an agreement to repurchase them at the same price at some specified future date - when the need for the funds has passed. When such an agreement is concluded, the bank purchases the bonds outright at a flat price, or a flat price plus accrued interest, with an agreement to sell them back to the borrowing institution at the same price plus interest at a stipulated rate upon the expiration of a certain period. The price agreed upon for purchase and resale is usually at or a few points below the prevailing market price. Regulations
of the Comptroller of the Currency authorize member banks to enter into
repurchase or resale agreements only when the member bank concerned has
the sole right or option under the agreement. Appended
is a typical form of bond repurchase agreement. General
Bond Repurchase Agreement
______________________________________________________________________ AGREEMENT
MADE THIS DAY OF _______________________, 19 _____________ Between ________________________________________________________________________
Bank and ______________________________________________________________________ WHEREAS, in consideration of the agreement to purchase hereinafter expressed, ____________________ Bank has this day agreed to purchase from ___________________________________________________ _____________________________________________________________________ at
a price of __________________________________________________flat.
The
______________________________________ Bank hereby agrees to resell said
lot of bonds to the __________________________________________
on or before 60 days from flat, plus interest on the purchase price at
the rate of ___________________________________________ percent per annum,
and the said _____________________________ hereby agrees to repurchase
said lot of bonds from the ________________________________________ Bank
on or before 60 days from the selling date, at the said price ____________________________________
flat, plus interest on the sale price at the rate of ________________________________________percent
per annum. THE
_________________________________ BANK By
________________________________________ Cashier ______________________________________________________ 2.
Member banks may borrow from a Federal
Reserve bank through the instrumentality of a repurchase agreement, which,
to all intents and purposes, is a collateral advance.
Eligible collateral is of four classes:
Treasury bonds, certificates of indebtedness, bankers' acceptances,
and eligible commercial paper. 3.
The form of repurchase agreement used
by Federal Reserve banks is appended. Federal
Reserve Repurchase Agreement
_________________________________________________________________
TO
FEDERAL RESERVE BANK, _________________________________________________________ The
_____________________________ Bank hereby offers for rediscount for __________________
days from date the bills and/or notes which are listed on this application
and agrees on _________________, 19, _______ to pay you the face value
of the same which are thereupon to be released to us.
If such payment is not made on said date, you are hereby authorized
to charge to our account the face value of said bills and/or notes and
to hold them for collection for our account, subject to our order.
________________________________ Bank
_____________________________________
Cashier ______________________________________________ |