What is a repo, and why does the whole system run on it?
A repurchase agreement — repo — is the largest, least famous market in the world. Trillions of dollars change hands in it every day, it is where SOFR comes from, and almost nobody outside the plumbing can define it. Let us fix that.
The definition, in one sentence
I sell you a security today and agree to buy it back from you on an agreed date at an agreed higher price.
That is the whole thing. Legally it is a sale and a repurchase. Economically it is a secured loan: you gave me cash, I gave you collateral, and the difference between the two prices is the interest. Collateral is an asset handed over to secure an obligation; if the obligation is not met, the side holding it may sell it to make itself whole.
Two names for one trade, depending on where you stand. The party handing over securities and receiving cash is doing a repo (it is borrowing). The party handing over cash and receiving securities is doing a reverse repo (it is lending). When you read that "the Fed does reverse repos," it means the Fed is taking in cash and giving out collateral — draining reserves, exactly as in the previous lesson.
The arithmetic
Repo interest is the same simple actual/360 calculation as any other money market instrument:
repurchase price = cash × (1 + rate × days / 360)
Overnight. $50 million lent at 4.30% for one night:
interest = 50,000,000 × 0.0430 × 1 / 360 = $5,972.22
repurchase price = $50,005,972.22
Term. The same $50 million at 4.30% for 30 days:
interest = 50,000,000 × 0.0430 × 30 / 360 = $179,166.67
Most repo is overnight, rolled every single morning. Term repo (a week, a month, occasionally longer) and open repo (no fixed end date, either side can terminate) fill out the rest.
Why the legal form is not a technicality
It would be simpler to write "secured loan" on the ticket. The market does not, and the reason matters: because title to the collateral genuinely transfers, the cash lender can sell the collateral immediately if the borrower fails. Repo enjoys safe-harbour treatment under the bankruptcy law of several major jurisdictions, exempting it from the automatic stay that freezes an ordinary creditor.
That single legal feature is why a firm can borrow in repo at a rate close to risk-free while its unsecured borrowing costs far more. The lender is not really lending to the firm; it is lending against the bond, with the firm as a bonus.
Why repo is the funding market
Follow who uses it:
- Dealers finance their bond inventory in repo. A dealer holding $30 billion of Treasuries does not own them with its own money — it repos them out every night.
- Leveraged investors finance positions the same way, which is where haircuts and leverage come in next lesson.
- Cash providers — money market funds, corporate treasuries, central counterparties, official institutions — need somewhere secured to put enormous balances for one night. Repo is that place.
The consequence: the repo rate is the marginal cost of holding a bond overnight. Any yield below it is a losing carry; any yield above it is positive carry. That is why the repo rate anchors the entire front end, and why SOFR is literally a repo rate — a volume-weighted median of overnight Treasury repo, which you will take apart in Unit 3.
In the data
Three of the five dollar overnight benchmarks are repo rates. Here they are for one night beside the two unsecured ones, each with the value of the loans it was measured on:
Read the volume rows before the rates. On 24 September 2026 SOFR stood on $2,990 billion of repo, and EFFR on $105 billion of unsecured interbank lending, almost thirty times less. The two rates printed the same 3.88% that night, but they are not two quotes on one market: one is the price of a three-trillion-dollar secured market, the other of a hundred-billion-dollar unsecured one.
Try it now
- Below is every SOFR fixing from 18 August to 24 September 2026. Find the highest and the lowest fixing, and compute one night's interest on $250 million at each.
- EFFR minus SOFR over the same window is below. Note which of the two sits higher, and how often the sign flips — the ordering is not fixed, and Unit 2 covers what moves it.
- Explain to an imaginary friend, in two sentences, why a repo is legally a sale but economically a loan, and why the distinction is worth money.