the transaction as perceived from the borrower’s angle is termed as a repo, whereas the same transaction as perceived from the lender’s angle is known as a reverse repo. Thus, every repo must be matched by a reverse repo. A dealer who is hunting for cash to fund an acquisition of securities will undertake a repo.
On the other hand, if he is hunting for securities to undertake a short sale, he will do a reverse repo. This is because the short sale transaction will require him to acquire and sell the securities and will in the process generate cash, which can be invested.
A repurchase agreement is subject to standard industry documentation and both legs of the transaction together constitute a single contract. In India, such transactions are known as ‘Ready-Forward’ or RF contracts, since the first leg, whereby the borrower pledges and gets the cash, is a spot transaction, while the second leg, whereby he commits to return the cash in return for the securities, is essentially a forward contract.
The collateral for such transactions is typically a government security. However, in the US, other debt securities, such as commercial paper may be offered as collateral.
The writer is the author of ‘Fundamentals of Financial Instruments’, published by Wiley, India