How Reverse Repurchase Agreements (RRPs) Work
Repos are classified as a money market instrument, and they are usually used to raise short-term capital. Reverse repurchase agreements (RRPs, or reverse repos) are the seller end of a repurchase agreement.1 These financial instruments are also called collateralized loans, buy/sell back loans, and sell/buy back loans.Reverse repos are commonly used by businesses like lending institutions or investors to access short-term capital when facing cash flow issues. In essence, the borrower sells a business asset, equipment, or even shares in its company. Then, at a set future time, the lender sells the asset back for a higher price.2
The higher price represents the interest to the buyer for loaning money to the seller during the duration of the deal. The asset acquired by the buyer acts as collateral against any default risk that it faces from the seller. Short-term RRPs hold smaller collateral risks than long-term RRPs because, over the long term, assets held as collateral can often depreciate in value, causing collateral risk for the buyer.1
