The Capital Markets

CHAPTER 9Repurchase Agreements

Karl Schultz and Jeffrey Bockian

INTRODUCTION

A repurchase agreement is a financing transaction executed when a holder of securities sells them to an investor and simultaneously agrees to repurchase them at the same dollar price on a specified future date. The difference between the sale price and the subsequent repurchase price represents interest over the period. In effect the seller of the securities is borrowing funds from the buyer and repaying the loan when the securities are repurchased. The term repo is used to describe the transaction from the perspective of the borrower or seller of the securities. The lender of the funds or purchaser of the securities initially is engaging in a reverse repurchase agreement (reverse repo). Repo transactions can alternatively be viewed as the economic equivalent of secured loans, where the seller of the securities is in effect borrowing funds from the buyer and pledging the securities as collateral. However, despite some economic similarities, repurchase agreements differ from secured loans as repos feature title transfer of collateral from the seller to the buyer. In contrast, a secured loan typically operates under a pledge structure in which the borrower retains ownership of the securities upon which the lender retains a lien. Another key difference between repos and secured loans is that repos are generally exempt from stay under the bankruptcy code. That means in an event of default, such as the ...