Here we look at secured borrowing and lending in the money markets.

A significant portion of money market transactions are secured or collateralized, meaning that instead of just borrowing money and promising to pay it back, the borrower provides the lender with valuable collateral or assets to secure the transaction if things go wrong.

The most well-known example of secured borrowing in the money markets is the repo or repurchase agreement.

Economically, a repo functions as collateralized borrowing. One party borrows cash from another in exchange for providing a bond or other security as collateral, and they pay an interest rate for the borrowed cash.

However, the term repo stands for repurchase agreements, which reflects how the transaction is set up legally.

At inception, the party borrowing cash called the repo party, sells the collateral such as the bond to the cash lender, the reverse repo party. The collateral is delivered and the agreed upon cash amount is received.

Simultaneously, both parties agree to repurchase the collateral at a future date, the repo maturity, the price at which the repo party will repurchase the collateral is pre-agreed at the time of the transaction and is usually higher than the original sale price.

The difference between the sale and repurchase price reflects the interest cost for the cash borrowed.

While this transaction is legally structured as a sale and repurchase, it is economically equivalent to secured lending for the cash provider or the reverse repo party.

Regarding the repo maturity, we distinguish between overnight repo and term repo.

The most common type of repo transaction lasts for just one business day and is therefore referred to as overnight repo.

Term repos last for more than one day, and the repo rate is generally slightly higher.