What Is Repo?
Repo (a repurchase agreement) is the sale of a security under an agreement to buy it back at a later, pre-agreed higher price. On the surface it is a purchase and sale; in operation it is short-term borrowing. The party selling the security has in effect borrowed cash, and the party buying it has lent cash; the security sold serves as the collateral for that loan. The gap between the sale price and the repurchase price is the return paid to the lender, and it is expressed like an interest rate; because the transaction is short-term, this rate is usually presented converted to an annual figure.
The key feature of repo is that the repurchase price is fixed at the outset. So the party giving the cash knows, on entering the transaction, exactly how much it will receive back at maturity; the return is independent of the security's market price moves in the meantime. In this respect repo differs from buying and selling a bond outright: a bondholder is exposed to price fluctuation, whereas the party lending into a repo targets a return set in advance.
How repo works: a step-by-step example
Consider an example. A party holding a government bond needs cash for a short while:
- Today: It sells its bond to the other party and receives cash in return.
- At the same time: It commits to buying that same bond back a few days later at a slightly higher price. Both prices are fixed in the contract from the start.
- On the maturity day: It pays the agreed higher price and takes its bond back. The price difference is the other party's gain.
The economic essence: one party has raised short-term cash by posting its bond as collateral, while the other has put its cash to work on a collateralized basis at a known return. The term is usually very short — often overnight or a matter of days.
Repo and reverse repo: two faces of one transaction
Repo and reverse repo are not separate transactions but the same contract seen from the two sides:
| Repo | Reverse repo | |
|---|---|---|
| Done today | Sells the security, takes cash | Buys the security, gives cash |
| Role | Borrower (needs cash) | Lender (putting cash to work) |
| At maturity | Buys the security back | Sells the security back |
In other words, one party's 'repo' is the other party's 'reverse repo'. When an investment fund puts its cash to work short-term, it is usually on the reverse repo side: it gives the money, takes the security as collateral, and at maturity gets its principal back plus a return.
Why it is considered low-risk: the role of collateral
This is where repo differs from unsecured lending. The party giving the cash holds a security in return — in Turkey this is usually government domestic debt securities, that is government bonds or bills. If the counterparty fails to meet its obligation on the maturity day, the lender can dispose of the collateral it holds and largely recover its claim.
This reduces risk; it does not eliminate it. The value of collateral can fluctuate, which is why in repo transactions the collateral is often kept at a value somewhat above the cash lent (a collateral margin). Even so, when a short term and government-security collateral come together, repo is regarded as one of the lowest-risk instruments in the money market. 'Low risk' here is a technical comparison; no return is guaranteed, and this page gives no investment recommendation.
Repo and money market funds
Repo is a central instrument for money market funds. These funds must be positioned in short-term, highly liquid assets, and repo/reverse repo fits that description exactly: very short-term, collateralized, and easily convertible to cash. As a result, a significant part of a money market fund's return comes from the interest spread on the reverse repo transactions in its portfolio. The fund keeps its cash continuously at work by rolling over many short-term transactions one after another; each one returns the principal plus a small gain at maturity, which the fund then puts to work again.
Which instruments these funds may invest in, including repo, and in what proportions, is set within the framework of the SPK Communiqué III-52.1 (Principles Regarding Investment Funds) and the related portfolio limits; a fund's portfolio allocation and transactions are disclosed to the public via KAP. You can see the weight of the repo/reverse repo item in a fund's composition in its information documents and portfolio allocation data.
Frequently asked questions
what is repo
Repo is the sale of a security (usually a government bond or bill) under an agreement to buy it back at a set later date for a higher price. Although it looks like a purchase and sale, at heart it is collateralized, short-term borrowing; the gap between the sale price and the repurchase price is the return on the transaction.
what is the difference between repo and reverse repo
They are not separate transactions but the two sides of the same contract. In a repo, a party sells its security and takes cash (the borrower); in a reverse repo, a party buys the security and gives cash (the lender). So one party's repo is the other party's reverse repo.
is repo safe
Repo is considered low-risk relative to unsecured lending, because the party giving the cash usually holds collateral such as a government bond or bill in return. The risk is reduced but not eliminated: the collateral's value can fluctuate and no return is guaranteed.
why do money market funds use repo
Money market funds must be positioned in short-term, highly liquid assets, and repo and reverse repo fit that description. These funds use reverse repo to put their cash to work on a collateralized, very short-term basis, and a significant part of their return comes from the interest spread on these transactions.
In short
Repo is the sale of a security under an agreement to buy it back later at a higher price; at heart it is collateralized, short-term borrowing, and the difference between the two prices is the return. Seen from the side lending the cash, the same trade is called a 'reverse repo'. Because the collateral is usually a government bond or bill, it is considered low-risk and is a major source of money market funds' returns; but the risk is not zero and this page is not advice.