In plain language — Money markets move cash over short periods. In a repo, one party obtains cash and transfers securities as collateral while agreeing to repurchase them; the same trade is a reverse repo from the other party's perspective.
A repurchase agreement is legally a sale with an agreement to buy securities back, but it is often read economically as secured financing. The difference between initial and repurchase prices sets the repo cost. A trade may be overnight or have a longer term.
Two settlement dates
On the first date, the cash provider sends cash and receives securities. On the second, the flows reverse at the agreed repurchase price. The rate can be derived from the price difference under the relevant day-count basis.
A haircut makes collateral market value exceed the cash advanced. It absorbs some potential price movement and liquidation cost but does not remove risk. Margining and collateral substitution may update protection during the trade.
“Repo” and “reverse repo” depend on viewpoint. The cash borrower using securities performs repo; the cash provider describes reverse repo. Legal documentation defines ownership, netting, default events and collateral rights.
General collateral, special and overnight benchmarks
In general collateral, obtaining funding against acceptable securities is central. A special security is particularly sought after and can finance at a different rate because access to that exact collateral has value. Specialness can change with scarcity, short positions and settlement needs.
The Secured Overnight Financing Rate (SOFR), published by the Federal Reserve Bank of New York, is a broad measure of the cost of borrowing cash overnight collateralised by U.S. Treasury securities. It uses transactions inside the official methodology and publication calendar. SOFR is not the rate on every repo: collateral, counterparty, venue, size and terms can differ.
Overnight rates connect monetary policy, reserves and demand for cash and collateral. The short end of the curve also reflects expectations, but one daily fixing does not determine the whole yield curve.
Operational and market risks
Collateralised trades still carry gap, counterparty, liquidity, custody, valuation and settlement risk. If a counterparty defaults while collateral loses value or cannot be sold quickly, the haircut may be insufficient. A financed position can face margin calls and forced deleveraging.
Funding maturity matters. Financing a long asset through overnight repo creates rollover risk: rates may rise or lenders may refuse renewal. Concentration in one counterparty, collateral type or maturity date magnifies exposure.
A professional control reconciles cash and securities by identifier, uses independent prices, verifies haircuts and margin calls, monitors fails and maturities, and stresses collateral price and funding availability together.
Common error — Calling repo risk-free because it is secured. Collateral mitigates loss under operational assumptions; it does not erase price, liquidity, gap or legal risk.
Questions this page answers
Who supplies cash? Which collateral transfers? What haircut applies and how is it margined? Is the trade overnight or term? Is the rate deal-specific or a benchmark? How are default, fails and rollover handled?
Sources
- Federal Reserve Bank of New York — Secured Overnight Financing Rate
- Federal Reserve Board — H.15 Selected Interest Rates
- TreasuryDirect — Glossary