It used to be that mainly US Treasuries (bear this in mind at all times) were used as security for Repo transactions, as it is considered as most secure i.e. as good as cash since it is backed by the credit of the US government!
This requirement is no longer the case. More of this issue later.
The Nature of Repo Transactions
In repo transactions, securities are exchanged for cash with an agreement to repurchase the securities at a future date. The securities serve as collateral for what is effectively a cash loan. A distinguishing feature of repos is that they can be used either to obtain funds or to obtain securities. As repos are short-maturity collateralized instruments, repo markets have strong linkages with securities markets, derivative markets and other short term markets such as inter-bank and money markets. [3]
Like other financial markets, repo markets are subject to credit risks, operational risks and liquidity risks. However, what distinguishes the credit risks on repos from that associated with uncollateralized instruments is that repos credit exposures arise from volatility (or market risk) in the value of collateral. Bear this in mind at all times.
Repos allow institutions to use leverage to take larger positions in financial markets which could add to systemic risks. Bear this in mind at all times.
And because of the close linkages between repo markets and securities markets, any shocks will be transmitted quickly, resulting in a gridlock. Bear this in mind at all times.
Transactions covered by definition of repos are as follows:
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