Which of the following correctly describes a "reverse repo"?

Which of the following correctly describes a "reverse repo"?
A . An asset swap that is offset by an identical but opposite swap
B . Lending cash with securities as a collateral
C . Borrowing cash while posting securities as a collateral
D . A repo with an undefined maturity period

Answer: B

Explanation:

A repo, or a repurchase agreement, is the lending of securities in return for cash, with an agreement to buy the securities back at a later date at the borrowed amount plus interest. It is a form of collateralized borrowing. A ‘reverse repo’ is exactly the opposite of a repo transaction, ie where cash is lent and securities borrowed. Therefore Choice ‘b’ is the correct answer. In any repo transaction, the counterparty will therefore always have a ‘reverse repo’ position.

A reverse repo is a useful transaction – not merely for the purpose of lending short term funds, but more importantly to enable short positions. For example, if an investor wishes to short a bond, he can borrow the bond on a ‘reverse repo’ and sell it. Of course, he will have to return the bond when the reverse repo matures, but hopefully by that time prices of the bond would have fallen to allow him to do so profitably. Short positions in physical bonds are nearly always facilitated by reverse repos.

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