CFAI Morning Q 7 B:
Answer: When the collateral is difficult to obtain, the buyer ( lender) is willing to accept a lower repo rate in order to access the scarce collateral, for exaple, to vover aq short sale. This special collateral is valuable to the lender of funds.
Can somebody make sense of this?
the collateral is scarce its difficult to obtain so the lender is willing to len you the funds at a lower rate so he can have the collateral because he migh need it for something else. so by accepting a lower rate he is paying a premium
Scarcity = lower rate. It’s a very backwards concept.
I’ll make things easier for you:
From Lowest to Highest
Delivery charges: N C W P
Repo Rates: P W C N
Memorize the first one (NCWP) for delivery charges … no delivery, custodian, wire, physical … and reverse it for the repo.
Lowest repo rates: physical, wire, custodian, no delivery (highest repo).
As for your question: imagine you have something which is really hard to obtain and the supply is REALLY low … so others would be reallyyyyyy interested in having what you already OWN … thus, if you give this “special” thing to the lender, he will be so happy he has such a precious collateral and he will be willing to give you a lower rate for that … (sounds like a bed time story)
Things which make the repo rate higher is increase in interest rate and increase in term (number of years).
I hope this helps …
This is good Bilal!
if its hard to obtain, it is probably easier to get rid off. so that harder it is, the cheaper the repo rate gets.
why is custodial more expensive than wire?
Not backwards at all: you give me valuable (scarce) collateral, I give you something of value (a lower rate).
This happens mostly with shorts. Many times short sellers use repos to short a stock, they borrow the security, lend money and recieve a repo rate. When a security is scarce and the short seller needs it, he won’t mind getting a low repo rate.