Repurchase agreement

A sale (and) repurchase agreement, also known as a (currency) repo, RP, or sale and repurchase agreement, is a transaction concluded on a deal date t_D between two parties A and B:

(i) A will on the near date t_N sell a specified security S at an agreed price P_N to B

(ii) A will on the far date t_F (after t_N) re-purchase S from B at a price P_F which is already pre-agreed on the deal date.

If we assume positive interest rates, the repurchase price P_F can be expected to be greater than the original sale price P_N.

The (time-adjusted) difference (P_F-P_N)/P_N*(t_F-t_N)/365 is called the repo rate; it can be interpreted as the interest rate for the period between near date and far date.

Ambiguity in the usage of the term repo

The term repo has given rise to a lot of misunderstanding: there are two types of transactions with identical cash flows

(i) a sell-and-buy-back as well as

(ii) a collateralized borrowing.

The sole difference is that in (i) the asset is sold (and later re-purchased), whereas in (ii) the asset is instead pledged as a collateral for a loan: in the sell-and-buy-back transaction the ownership and possession of S are transferred at t_N from a A to B and in t_F transferred back from B to A; conversely, in the repo only the possession is temporarily transferred to B whereas the ownership remains with A.

Official bank rate

The official bank rate (also called the Bank of England base rate or BOEBR) is the interest rate that the Bank of England charges Banks for secured overnight lending. It is the British Government's key interest rate for enacting monetary policy. It is more analogous to the US discount rate than to the Federal funds rate. The security for the lending can be any of a list of eligible securities (commonly Gilts) and are transacted as overnight repurchase agreements. Changes are recommended by the Monetary Policy Committee and enacted by the Governor.

History

The official bank rate has existed in various forms since 1694 and has ranged from 0.5% to 17%. The name of this key interest rate has changed over the years. The current name "Official Bank Rate" was introduced in 2006 and replaced the previous title "Repo Rate" (repo is short for repurchase agreement) in 1997. Previously (between 1981 and 1997) the title was "Minimum Band 1 Dealing Rate" and prior to that the "Minimum Lending Rate".