What it means
The same transaction carries two names depending on which side you sit. The party selling securities and buying them back is doing a repo, while the party handing over cash and holding the collateral is doing a reverse repo.
It matters because these trades are the plumbing of short-term money markets, where banks, money market funds and corporate treasurers park or borrow cash against government bonds, often overnight. For a treasurer with $50,000,000 sitting idle for a week, a reverse repo earns interest with high-quality collateral behind it rather than leaving the money as an unsecured bank deposit.
The cash advanced is deliberately less than the market value of the collateral, and that cushion is called the haircut. It protects the lender if the collateral falls in value or the borrower fails before the trade unwinds, and it is larger for riskier or less liquid securities.
Rates are quoted as an annualised percentage using an actual over 360 day count, which is the convention in most money markets. Most trades are overnight, but terms of a week to three months are routine, and open trades roll daily until either side ends them.
Central banks run very large reverse repo facilities to drain surplus cash from the banking system and put a floor under short-term interest rates, which is why the term appears in monetary policy commentary. On a company balance sheet, reverse repos usually sit within cash equivalents or short-term investments depending on how long they run.
In practice
Real-world examples.
Example
A money market fund lends $200,000,000 overnight at 5.25% against Treasury collateral. Interest for the single day is $200,000,000 x 0.0525 x (1 / 360) = $29,166.67, and the fund holds the bonds until the cash comes back the next morning.
Example
A corporate treasurer places $25,000,000 for 30 days at 4.80% rather than leaving it on deposit. Interest is $25,000,000 x 0.048 x (30 / 360) = $100,000, and the collateral means the position does not use up the company's unsecured exposure limit for that bank.
Example
A trading desk needs a specific bond to settle a short position, so it lends $5,000,000 of cash for 3 days at 4.50% and takes that bond as collateral. The interest of $5,000,000 x 0.045 x (3 / 360) = $1,875 is a side benefit; the real purpose was borrowing the security.
Formula
Calculation
Interest = Cash Lent x Rate x (Days / 360). Repurchase Price = Cash Lent + Interest. Haircut % = (Collateral Market Value - Cash Lent) / Collateral Market Value.
A corporate treasury lends cash against $10,000,000 of government bonds with a 2% haircut, so the cash advanced is $10,000,000 x 0.98 = $9,800,000. The agreed rate is 5.00% and the term is 7 days. Interest = $9,800,000 x 0.05 x (7 / 360) = $9,527.78. The repurchase price the counterparty pays back is $9,800,000 + $9,527.78 = $9,809,527.78. The treasury has earned $9,527.78 for one week while holding $10,000,000 of bonds as security, and if the counterparty had failed it could have sold the collateral to recover the $9,800,000 it lent.Case study
Seen in the real world.
Thornbury Instruments is an illustrative, fictional equipment maker that closed a funding round and found itself holding $40,000,000 it did not need for fourteen days, pending a factory payment. The treasurer's first instinct was a short bank deposit at 4.60%, which would have earned $40,000,000 x 0.046 x (14 / 360) = $71,555.56.
Her second thought was credit exposure. A deposit would have left the full $40,000,000 unsecured with a single bank for two weeks, which breached the board's counterparty policy. A reverse repo against government bonds at 5.10% earned $40,000,000 x 0.051 x (14 / 360) = $79,333.33, a gain of $7,777.77 over the deposit, and the position was secured by collateral held through a tri-party agent.
The point of this fictional example is not the extra income, welcome though it was. It is that the secured structure let the treasurer place the whole balance in one place without breaching an exposure limit, whereas the deposit route would have meant splitting the money across three banks and chasing three sets of paperwork for less interest.
Watch out
Common mistakes.
- Confusing the two sides of the trade and describing a cash-lending position as a repo, which reverses the direction of the exposure being reported.
- Treating the transaction as risk-free because collateral exists, when a falling collateral price combined with a counterparty failure can still leave a shortfall.
- Ignoring the haircut when calculating the return, since the interest is earned on the cash actually lent, not on the face value of the collateral.
Questions
People also ask.
Is the collateral owned outright by the lender?
Legally title usually passes, but the economics are those of a secured loan, and the securities are expected to go back at the agreed date.
Why use 360 days rather than 365?
It is the long-standing money market convention in most currencies, and it slightly increases the interest paid for any given quoted rate.
Where does it appear in the accounts?
Typically within cash equivalents or short-term investments, with the collateral disclosed but not recorded as an owned asset.
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