Regulations

• The second party holds the stock or bond as collateral for the loan. If the first party can't come up with the cash to repay the second party, the second party gets to keep the securities. According to the Commodity Futures Trading Commission, the second party can't use the same stock as collateral for more than one loan, and it can't sell the stock to another buyer before the contract ends. The second party must separate the stock from its other investments and hold it in a secure account.
  
  

Counterparty Risk

• Since reverse repurchase agreements involve a loan, they're risky. The second party must pay cash immediately after signing the agreement, and it expects the first party to buy back the stocks or bonds in the future. If the first party spends the cash from the loan and can't afford to repurchase the stocks or bonds at a later date, the second party may not be able to sell these instruments at their earlier price.
  
  

Short-Sale Comparison

• A reverse repurchase agreement is similar to a short sale, because a short sale also involves a promise to purchase stock at its current market price at a future date. Unlike a short sale, the second party can't sell the stock and buy it back at its market price in the future. A short sale is more risky than a reverse repurchase agreement, because an investor who sells the stock in a short-sale agreement may have to pay a higher price to buy back the stock to resell it to the other party.
  
  

Time Frame

• Reverse repurchase agreements usually have a short time frame. A government agency with cash it needs to spend in the near future can earn interest from this short-term loan by acting as the second party. The main benefit that the second party receives from the reverse repurchase agreement is the interest payment from the first party.
  
  

Market Risk

• The reverse repurchase agreement involves a risk that doesn't exist with other types of loans. If the first party borrows $100,000 from the second party using a standard loan, the first party pays back $100,000 plus interest. If the first party borrows $100,000 with a repurchase agreement, using stocks that trade at $50 a share as collateral, and the price of a share drops to $25 at the end of the contract date, the second party only receives $50,000 back, plus the loan interest.