Understanding Repo, EFFR, and SOFR: A Practical Guide with Real-World Examples

Why These Rates Matter

Imagine you’re trying to understand how money moves through the financial system. Three key rates — Repo, EFFR, and SOFR — act like vital signs that tell us how healthy the financial markets are. Just as a doctor checks your heart rate and blood pressure, economists and traders watch these rates to understand what’s happening in the financial world.

I. The Repo Market: Understanding the Financial World’s Favorite IOU

What is a Repo?

A Simple Example
Imagine you need $1,000 for a week, and you have a valuable watch worth $1,200. Instead of selling your watch, you make this deal with a friend:
- You give them the watch now
- They give you $1,000
- In a week, you’ll pay them $1,001 to get your watch back
- The $1 difference is effectively the interest (repo rate)

This is exactly how a repo works in finance, just with government securities instead of watches, and banks instead of friends.

Real-World Example: How Banks Use Repos