Repurchase orders or repos as commonly referred to, are an investment tool that is not known to many people; just like the Forex market too. Probably due to its limited use, many people may not even have come across it anywhere.
A repo involves a short-term loan transaction that involves two parties. One party has urgent financial needs and therefore they would like to borrow some cash. The other party has cash to lend and they are looking for someone to lend to. When the two parties come together, a transaction takes place whereby the lender ends up gaining some money by the end of it.
The transaction that takes place involves the borrower selling a repurchase order to the lender (buyer of the repurchase order) who then lends them the money they needed. The repurchase order is a document that contains the contract details of the transaction whereby the buyer has lent money to the seller of the repo; with an intention of reselling back the repo to the seller at some future date at a higher price.
The buyer of the repo therefore makes money by reselling the repo back to the initial seller at a higher price than they had bought it. The difference between the buying and selling price of the repo is what makes profits for the buyer of the repo. In other words: if the buyer lent the seller of the repo ksh. 100,000 and it is stipulated in the repo that he is to get ksh. 120,000 at the expiry date of the repo, then the ksh. 20,000 is the gain that the buyer gets from the transaction. In this case then, the interest rate of the repo is 20% (20,000/100,000 * 100)
Just like any other loan, a repo requires collateral before the contract can be sealed. In many cases, collateral offered by repo sellers is quickly tradable securities such as shares, treasury bonds and bills and corporate bonds too. These forms of securities can be liquidated very fast and that is why they are preferred by the repo buyers.
Repos term can last for as short as one day, or be as long as two years. However, most repos are short term and they last for between a day and a week.