InvestorQ : What is a Repo trade and how is it different from a normal buy or sell transaction?
Mahima Roy made post

What is a Repo trade and how is it different from a normal buy or sell transaction?

Aditi Sharma answered.
3 years ago

An outright Buy or sell transaction is a one where there is no intended reversal of the trade at the point of execution of the trade. The Buy or sell transaction is an independent trade and is in no way connected with any other trade at the same or a later point of time.

A Ready Forward Trade (which is normally referred to as a Repo trade or a Repurchase Agreement) is a transaction where the said trade is intended to be reversed at a later point of time at a rate which will include the interest component for the period between the two opposite legs of the transactions. In fact, REPO is the short for Repurchase Option.

So in such a transaction, one participant sells securities to other with an agreement to purchase them back at a later date. The trade is called a Repo transaction from the point of view of the seller and it is called a Reverse Repo transaction from point of view of the buyer.

Repos are critical because they facilitate creation of liquidity by permitting the seller to avail of a specific sum of money (the value of the repo trade) for a certain period in lieu of payment of interest by way of the difference between the two prices of the two trades.

Repos and reverse repos are commonly used in the money markets as instruments of short-term liquidity management and can also be termed as a collateralised lending and borrowing mechanism. Banks and Financial Institutions usually enter into reverse repo transactions to manage their reserve requirements or to manage liquidity.