Repurchasing agreements are contracts which temporarily exchange cash for securities. These are loans where securities serve as collateral until payment is made, and the bonds are then delivered back to the original bondholder.
The repurchase price of the agreement must exceed the actual sale price. The difference between the two prices is the repurchase rate, or the interest. This makes a repurchase agreement a short term loan. They usually are overnight but sometimes last a few days. The cash is used to invest in short terms, while maturities and cash earnings from other investment assets give liquidity needed to fulfill the arrangement. If the firm cannot meet the repurchasing agreement, they lose the securities which have been posted for collateral, which the purchaser can sell to recover their loss, or hold to maturity. Repurchasing agreements enable loans that would otherwise be rejected; they are safer with posted collateral than they would be without them.
Repurchasing arrangements typically occur between institutional investors and dealers. These large investors will often stake positions around these promises, utilizing repurchase agreements as a way to switch investment positions quickly.
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