A repurchase agreement is effectively a fully collateralized loan that results in a sale of securities to the lender. The securities used as collateral are most often government securities, such as Treasury notes or bonds. The borrower agrees to repurchase the securities from the lender at a slightly higher price in the future. The higher price represents the lenders interest.
Applying "Repurchase Agreement (REPO)" to Securities Exams:
A repurchase agreement is a fully collateralized loan made between a dealer and a large institutional investor. These loans are usually collateralized with U.S. government securities that have been sold to the lender.The borrower (seller) agrees to repurchase the securities from the lender at a slightly higher price. The slightly higher price represents the lender’s interest. Test takers can get thrown off course by questions that describe repos. The questions try to lead the test taker to believe that the arrangements violate industry rules because the arrangement guarantees the lender / seller a profit.. Don’t bee fooled by these questions. The repo is a perfectly acceptable arrangement and it is much easier to enter into than obtaining a short term loan and by pledging the Treasury securities as collateral. Repo agreements can have maturity dates that are fixed or open and repos often trade in the money markets.