Confused by this one. Schweser Secret sauce pp134. Why does it says if the availability of the collateral is LIMITED, the repo rate will be lower?? I think it should be higher since the availability of collateral will reduce the risk and hence lower repo rate? Hence if it is limited then is should be higher. Thanks.
This is confusing. Instead of limited, they should have used the word “scarce”. If the collateral is scarce and highly sought after, then the counterparty will charge you a lower rate in order to get their hands on it.
pmoonoi Wrote: ------------------------------------------------------- > Confused by this one. Schweser Secret sauce > pp134. > > Why does it says if the availability of the > collateral is LIMITED, the repo rate will be > lower?? I think it should be higher since the > availability of collateral will reduce the risk > and hence lower repo rate? Hence if it is limited > then is should be higher. Thanks. You are confusing two things: 1. Whether the borrower delivers collateral on the loan or not - if they do not deliver the collateral (which I think is the way you are interpreting"availability"), then it does indeed mean that the lender will require a higher repo rate. 2. Assuming the borrower does deliver collateral, whether the availability of that collateral is limited, implying that there is value to holding the collateral - in this case, if the collateral is less available, then the lender will be willing to accept a lower repo rate in exchange for making the loan because the lender will have access to the “rare” collateral for other agreements.
The key thing about repurchase agreements is to remember the cash side of the trade – one of the counterparties is lending money to the other one at a certain interest rate. That loan is backed by collateral. From there the logic usually takes care of itself. If you are posting collateral to me that is very limited and hard to find, then I might be willing to accept a lower rate on the loan I am giving you. In cases such as these (we call them “specials”) the borrower of the collateral (the lender of the money) is usually someone who is short that particular bond and needs to borrow it temporarily to make good on another trade.
It’s a “I need to cover my ass” reduction in the rate. ; )
Thanks to all - really appreciate it. Yes guess I am confused with the word availability. I should hv assumed it is always available (ie since repo agreement is essentially a collaterized loan). Then we just need to assess the dd vs ss of the collaterals (yes scarce will be a better word) - if it is short supply RELATIVE to dd then I will accept a lower rate for the lower risk.
it’s like a limited edition!