Updated for the 2026-2027 CFA® Level I curriculum.
A repurchase agreement combines a sale of securities with a commitment to repurchase them later. Economically, it is secured short-term borrowing.
Quick Answer
In a repurchase agreement, the cash borrower transfers securities to a cash provider and agrees to repurchase them at a higher price. The securities serve as collateral. The difference between the initial cash and repurchase price represents repo interest.
Key Takeaways
The securities seller is economically the cash borrower.
The securities buyer is economically the cash lender.
The repurchase price equals principal plus repo interest.
A haircut makes collateral value exceed the cash advanced.
Collateral reduces risk but does not eliminate it.
What You Need to Know for CFA Level I
Trace the opening and closing legs of a repo.
Identify the cash borrower and cash provider.
Calculate simple repo interest when inputs are given.
Explain the purpose of a haircut and major repo risks.
This note covers repo mechanics. Broader funding-choice comparisons belong on Short-Term Funding Alternatives.
What Is a Repurchase Agreement?
A repo is structured as a sale and future repurchase of securities. Its economics resemble a collateralized loan: one party receives cash and provides securities, while the other provides cash and receives the securities as protection.
How a Repo Transaction Works
At the opening, the cash borrower transfers collateral and receives cash.
During the term, collateral may be valued and margin may be adjusted.
At closing, the borrower pays the agreed repurchase price and receives the collateral back.
Why Market Participants Use Repos
Borrowers use repos for short-term financing. Cash investors use reverse repos to invest cash on a secured basis. Dealers use them to finance inventories and support securities-market liquidity.
Repo Rate, Haircut, and Margin
The repo rate determines the financing cost of the transaction over the repo term. Use the following formulas to calculate the repo interest and the amount the borrower must repay at maturity.
Where:
Repo interest = financing charge paid over the repo term
Cash borrowed = amount advanced by the cash lender
Repo rate = annualized financing rate expressed as a decimal
Days = length of the repo term
Day-count basis = annual day convention used in the calculation
Repurchase price = cash returned at maturity, including repo interest
The repo rate prices the cash borrowing. A haircut means cash advanced is less than collateral market value. Margin adjustments help maintain protection when collateral value changes.
Benefits and Risks of Repos
Collateral can make a repo useful to both parties, but protection depends on its value and the ability to close out the trade. The table pairs each benefit with a risk to check.
Benefit | Related risk |
|---|---|
Secured short-term cash | Counterparty may fail to close |
Collateral protection | Collateral value or liquidity may fall |
Flexible maturity | Funding may not roll over |
Supports dealer activity | Operational or settlement errors can occur |
Working Example
A dealer borrows USD 5,000,000 overnight at a 3.60% repo rate on a 360-day basis. Repo interest is . The repurchase price is USD 5,000,500. If collateral worth USD 5,100,000 supports the cash, the excess collateral provides a haircut. The rate prices the loan, while the haircut protects against collateral loss.
Common Exam Traps
Treating the initial securities sale as an ordinary permanent sale
A repo pairs that sale with an agreement to repurchase the securities later; economically, it is a collateralized borrowing by the securities seller.
Reversing the cash borrower and lender
The party selling securities and promising to repurchase them receives cash now and borrows; the party providing cash holds the collateral and lends.
Calling a haircut the repo interest rate
A haircut is the excess of collateral value over cash lent, expressed under the stated convention. The repo rate measures the financing cost between the sale and repurchase prices.
Assuming collateral removes every risk
A fall in collateral value, a counterparty default, or delays in liquidating collateral can still create losses. Margin calls and haircuts reduce exposure but do not eliminate it.
Practice Question
A repurchase agreement is best understood economically as:
secured short-term borrowing
an unsecured long-term bond issue
an equity repurchase by a corporation
Correct Answer: Option A
A repo is economically secured short-term borrowing because securities serve as collateral for the cash loan.
Option B: A repo is typically short term and secured, not a long-term unsecured bond issue.
Option C: A corporate share repurchase involves a company buying its own equity and is different from a repo transaction.
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FAQs About Repurchase Agreements (Repos)
What is a repurchase agreement?
It is a sale of securities combined with an agreement to repurchase them later, producing secured-borrowing economics.
How does a repo work?
The borrower receives cash and transfers collateral, then repays cash plus repo interest to recover the collateral.
What are the main risks of repurchase agreements?
Key risks include counterparty, collateral, liquidity, operational, and rollover risk.