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Reverse Repurchase Agreement (Reverse Repo)

A reverse repurchase agreement, or reverse repo, is a short-term borrowing arrangement in which a party buys securities with an agreement to sell them back at a specified price and date, effectively providing a short-term loan. In this transaction, the buyer (usually a central bank or financial institution) is lending money, while the seller is borrowing and providing securities as collateral. Reverse repos are commonly used by central banks to manage liquidity in financial markets.

Example

A central bank conducts a reverse repo by purchasing government bonds from a commercial bank and agreeing to sell them back the next day, temporarily injecting liquidity into the banking system.

Key points

• A short-term borrowing arrangement where securities are bought and sold back at a specified price and date.

• The buyer provides a short-term loan, and the seller provides securities as collateral.

• Commonly used by central banks to manage liquidity in financial markets.

Quick Answers to Curious Questions

In a reverse repo, the buyer is lending money and the seller provides securities as collateral, while in a regular repo, the buyer is borrowing money.

To manage short-term liquidity in financial markets, temporarily injecting or withdrawing funds as needed.

The primary risk is counterparty risk, where the seller may default and fail to repurchase the securities.