This was in answer in a topic test for FI. How is this the case? I thought the term struture of interest rates (and repo rates) would suggest that rolling over shorter term repos would be approximately equal to entering a single long-term repo???
If it’s upward sloping then rolling over (1.01)^3 would be cheaper than (1.03)^3
Isn’t it otherwise, s/t rates falling environment. So
@t. 1m: 3% ; 2m: 3%
1m@t+1: 2%; 2m: 3%
rolling over the repo is going to cost you <3% vs 3% when funding for 2m at one shot, ignoring trading cost differential
You just need the rates to not follow the implied forward curve for it to be better.
Yea i’m not sure why it’s the case…just one of those things I’ll have to remember that doesnt have a good explanation
If the yield curve doesn’t change, you can roll over 1.01*1.01*1.01…n
Better than (1.03)^n
If you’re assuming the 3 month repo rate is 3% and the month repo rate is 1%, then rolling over would be more expensive:
1.01^3 > 1.03^1
I get your point on an upward sloping yield curve, but if the yield curve was upward sloping, that would suggest that short-term forward rates (e.g., 1 month rates in the above example) would also be increasing. So if actual rates evolve as suggested by the forward curve, there should be equivalence to rolling over three 1-month repos and the cost of one three-month repo.
If the rates are annualized, it’s cheaper.
Take yearly rates for a simpler case. 1 year vs 3 year repo.
1.01*1.01*1.01 ~ 3%
1.03^3 ~ 9%