Concept
-
Finally, repurchase agreements — or repos— can be viewed as a money market instruments (although they are not always classified as such). Repurchase agreements involve transactions whereby one party sells an asset that they own to their counter-party, with the agreement to buy it back (i.e. to repurchase it) at a pre-agreed time and price which is usually higher than the initial purchase price. This agreement resembles a loan: the selling party gets immediate access to the money and must repay it to the lending party with interest. Repayment in this context occurs when the borrowing party repurchases their asset, with the interest is the result of the increased repurchase-price. When viewing the arrangement as a loan, the asset that is being repurchased can be thought of as collateral underlying the loan. In effect the lender is allowed to hold onto this asset until the loan is repaid, which mitigates the default risk typically associated with loans, as the borrower forfeits the collateral in the event of default. It important to note that there can be additional complexities around repurchase agreements — such as how income or costs associated with the underlying asset are handled in the agreement; however, such considerations are beyond the scope of our current discussion.