A repurchase agreement (repo) is a type of short-term cash loan and is widely considered the closest sibling of securities lending.
In a repo transaction, a fixed income security is sold with an obligation to buy it back in return for cash. At the end of the term, the buyer returns the security and the seller returns the cash payment plus an additional interest payment.
In this case, the seller of the securities is called the borrower and the buyer of the securities is called the lender. This refers to the movement of the cash.
In a repurchasing agreement, the lender is exposed to the risk that the borrower will not repurchase the securities. Should the borrower fail to repurchase the securities within the agreed timeframe, the lender can sell the securities on the market, but often to mitigate this risk the borrower will offer collateral in the form of securities.
The key difference for the owner of securities between a repo transaction and a securities lending transaction is that in a repo transaction they pay interest whereas in a securities lending transaction they receive interest. Furthermore, in a repo transaction, the owner of the securities is often obligated to post collateral whereas in a securities lending transaction the owner of the securities often receives collateral.
Securities lending and repo are part of the broader category of securities finance as they both facilitate the temporary transfer of securities, on a collateralised basis, in return for an agreed interest rate that is accrued daily. However, the mechanics of a repo transaction are different from those of a securities lending transaction. Also, a repo agreement is usually governed by a different contractual agreement than a securities lending transaction, which is called a Global Master Repurchase Agreement (GMRA).
With securities lending, as with other investment activities, your capital may be at risk.
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