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A repurchase agreement is a short-term borrowing transaction in which one party sells securities to another with a simultaneous contractual commitment to buy those same securities back on a specified future date at a higher price. The difference between the sale price and the repurchase price is the interest cost, called the repo rate. From the buyer's perspective, the transaction is a reverse repo: they buy securities today and sell them back later, earning the difference as interest on what is effectively a secured loan.
Think of it as a pawn shop transaction for institutions: you hand over Treasuries as collateral and get cash today, with the commitment to reclaim the securities when you repay.
A dealer bank needs $500 million of overnight funding. It sells $500 million of U.S. Treasury securities to a money market fund at today's price. The contract specifies that tomorrow morning, the dealer will repurchase those same securities at $500 million plus one day's interest at the agreed repo rate.
From the dealer's perspective, this is borrowing secured by Treasuries. From the money market fund's perspective, this is lending secured by Treasuries. The securities function as collateral. If the dealer fails to repurchase, the fund keeps the securities, which are worth approximately what it paid.
Most repos are overnight: the securities are sold today and repurchased the next business day. Term repos run for a fixed number of days, from 2 days to several months. Open repos have no specified end date and can be terminated by either party with one day's notice.
The Federal Reserve conducts both overnight repos, to add temporary reserves to the banking system, and reverse repos, to temporarily drain reserves, as tools of monetary policy. The Federal Reserve's overnight repo operations are one of the largest short-term funding markets in the world, with daily volumes typically exceeding $1 trillion.
Lenders in repo transactions typically require more collateral than the amount of cash lent, a difference called a haircut. If the haircut is 2%, a $100 million cash loan requires $102 million of securities as collateral. The haircut compensates for price risk: if the borrower defaults and the lender must sell the securities in a stressed market, the extra margin protects against the possibility that prices have declined.
Haircuts are larger for riskier collateral. A repo collateralized by on-the-run U.S. Treasury securities might have a haircut of 1%. A repo collateralized by high-yield corporate bonds might carry a 10% to 15% haircut because those bonds are more volatile and less liquid.
Repo markets were at the center of the 2008 financial crisis. Investment banks including Bear Stearns and Lehman Brothers funded much of their mortgage-backed securities portfolios through short-term repo agreements. When counterparties lost confidence in the value of those securities, they refused to roll over the repos at maturity. The banks could not obtain overnight funding and collapsed or required emergency government intervention within days.
This run on repo illustrated a fundamental vulnerability: long-dated illiquid assets funded with overnight short-dated liabilities are catastrophically fragile when creditor confidence evaporates. Regulatory reforms following the crisis imposed liquidity coverage ratio and net stable funding ratio requirements on banks specifically to reduce this mismatch.
With deep roots in traditional finance and the digital asset industry, Acquire.Fi operates as a specialist M&A advisory firm. Coverage spans M&A, secondaries, OTC, and capital markets advisory across digital assets and frontier tech. Decades of combined experience across every stage of the deal lifecycle.
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