I continue learning Fixed Income securities and using Pietro Veronese book.

Here are some important characteristics of repo market:

General Collateral Rate (GCR) is the repo rate on most Treasury securities so called off-the-run securities. Because most of them have very similar liquidity characteristics they have pretty much the same collateral interest rate.

Special Repo Rate. Some particular securities are sometimes in high demand (on-the-run) and a repo rate for these securities falls significantly below GCR.

Why the Special Repo Rate is lower? It’s because of reverse repo transactions. In this case the trader borrows the on-the-run security from the repo dealer, sells it and uses sale proceeds as a cash collateral (effectively lending money to the repo dealer). In this case the trader gets repo rate. However in the case of reverse repo transaction the trader wants to short the bond, i.e. buy the security when it will become less liquid at the lower price and return security to the repo dealer getting collateral money back. In this case the trader is happy to forgo the part of the repo rate.

If the dealer held the cash collateral during the number of days ndays, repo rate was specialRate and initial price of the security was sellPrice then the repo interest paid to trader will be:

let daysRate (ndays, specialRate) =

    days / 360.0 * specialRate

let repoInt ndays repoRate buyPrice haircut =

    let repoRateDays = daysRate (ndays, repoRate)

    (buyPrice - haircut) * repoRateDays

If trader will buy the security after ndays days at pay price buyPrice then return on capital for trader will be:

Let profit = (sellPrice – buyPrice) + repoInt

These reverse repo agreements became popular because the risk for trader is small – in the case if it will not deliver bond back it will lose mostly the repo interest. During the time of recent financial crisis failures to deliver bonds in the reverse repo transactions became very frequent. The Federal Reserve conducts repo transactions daily in its open market operations and because of failures to deliver it introduced penalty charge of 3% for such failure starting May 1, 2009. One of the interesting consequences of this penalty is that on May 2009 repo rates for some of the securities became negative.