What is a reverse repo?

A reverse repo, or reverse repurchase agreement, involves selling a security with the agreement to buy it back at a specified price. This financial transaction typically takes place between two parties where one party sells the securities to the other and commits to repurchase them at a later date, usually within a short timeframe. This process is commonly used by institutions, including banks, to manage liquidity and generate short-term financing.

The agreement to repurchase at a predetermined price means that the seller effectively alters their exposure to the underlying securities temporarily while still maintaining ownership. The reverse repo arrangement allows the seller to acquire cash while providing the buyer with a short-term investment with little risk attached, as they have a firm commitment for the repurchase.

Understanding reverse repos is essential in the context of central banking operations and money market dynamics, where they are frequently utilized for managing cash reserves and influencing short-term interest rates.