Question: Availability of collateral is limited, why will resulting into the repo rate to be lower? Is that indicate the lower liquidity of collateral, the lower the repo rate?
The collerateral’s availablity is limitied. I.e. There ain’t a lot of these out there - but some people need it for some weird reason (e.g. cover a short). If he cannot borrow it from you, he’ll have to buy it back at an inflated price (short squeze). So, you are there at the other side of the table and what does your negociation power look like? Pretty good, right?
It’s like supply and demand. The demand for the collateral is high but very few owner’s, so the market value of the collateral should be higher.
olivier is perfect. But to explain more: Support you shorted Microsoft thinking the price will go down and you can buy from the market at a lower rate and deliver at a future date. The date you have to deliver the microsoft is tomorrow. You find out from the market that the microsoft (instead of going down to its fundamental/intrinsic value) is being quoted at a higher price which you again think is not reasonable. But when market participants know that someone has shorted heavilily (in this case you) and you have to buy microsoft stock in order to deliver them tomorrow, they jack-up prices creating NON-AVAILABILITY. You do not want to buy from market the stocks at more than fundamental value. Now you know a Mutual fund manager who has microsoft in his portfolio. and also you know that due to meet some redemptions the mutual fund manager wants money to borrow. Here, you can borrow stocks from him for temporatily (because one you cover shorts i.e. after you transaction is over, there will be microsoft stock availbale in the mkt and due to this the mkt price will go down clost to its fudamental value), and lend him money at say reduced rate. A few days later you can buy microsoft from the market and give them to the PF manager. Hope it helps.