Repo is a financing transaction that mainly involves government securities, where a dealer or a holder of government securities such as bills, notes, or bonds, sells the securities to a lender and simultaneously agrees to repurchase them at an agreed price on a prespecified future date. The lender receives, by virtue of such an agreement, an extremely low-risk return, as the securities are used as collateral to eliminate counterparty risks (in this sense they are similar to secured loans).

Repos allow a market player to sell a security to another with a simultaneous commitment to buy the security back at a certain date in the future (near future), often the next day, at a specified price. The difference between the sale and repurchase price of the security constitutes the implied interest rate (repo return or repo interest).

A repo transaction has an economic effect similar to that of a collateralized loan. The cash investor (repo buyer) in a repo receives securities as collateral as a protection against the risk that the counterparty would be unable to repurchase the securities at the agreed date. The market value of collateral (the securities posted) typically exceeds the amount of cash invested in a repo by an agreed-upon margin (repo margin or repo haircut). The repo margin is typically proportionate to credit worthiness of the borrower: the lower the credit worthiness, the higher the repo margin, and vice versa. Repo margin is meant to help lenders reduce their credit risk exposures. It provides some cushion especially in cases where the collateral’s market value decreases and hence sets lender exposed to potentially higher levels of credit risk.