A repo, or repurchase agreement, is a short-term financing mechanism where one party sells securities to another with an agreement to repurchase them at a higher price on a specified future date. The difference between the sale and repurchase prices represents the interest cost.
Repos are primarily used between central banks and commercial banks to manage short-term liquidity. For example, a commercial bank might sell $100 million in government bonds to the central bank and agree to buy them back the next day at $100.01 million, with the $10,000 difference representing the repo rate.
The repo market plays a crucial role in monetary policy implementation, helping central banks control money supply and short-term interest rates. It is one of the largest and most important segments of the financial market.