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Compare repos backed by general collateral against those backed by special collateral.

FRM® Part II · Liquidity and Treasury Risk Measurement and Management · Repurchase Agreements and Financing · FRM2.LTR.13.e

The idea

In a general collateral (GC) repo the cash lender does not care which security it receives, as long as it belongs to an agreed class such as US Treasuries. The securities are interchangeable and the rate is the GC rate, which tracks the general short-term cash rate. In a special repo the lender of cash is lending against one specific security, often because someone needs that issue to deliver against a short sale. The security's owner is then lending something scarce, so the cash lender accepts a lower rate to obtain it. The special repo rate is below the GC rate, and the gap is the price of borrowing the security. Because any owner can always use the bond as GC collateral, a special rate should not exceed the GC rate. A common error is to think special collateral earns the lender a higher rate.

Formulas

Cost to the cash lender of borrowing a special bond

Benefit = Cash × (GC − Special) × Days ÷ 360

Cash
the cash in the repo, after any haircut
GC
the general collateral repo rate
Special
the repo rate on the specific security
Days
days the repo runs

The fee is the interest given up against GC, not the interest earned at the special rate. It is the owner's benefit seen from the other side.

A practice question

From the question bank, with the reason each wrong option is wrong.

In which respect does a general collateral (GC) repo differ from a special repo?

  1. In a GC repo the lender requires a specific security, whereas in a special repo any security in a class is acceptable.Why not: Reverses the definitions of GC and special.
  2. A GC repo is unsecured, whereas a special repo is collateralised.Why not: Both are collateralised; the difference is how specific the collateral is.
  3. GC lets any security in an agreed class be delivered; special requires one specific security. - correct
  4. A GC repo is always overnight, whereas a special repo always has a term.Why not: Tenor is not what separates them; either can be overnight or term.

GC trades are about the cash: the lender takes any collateral in the agreed class. Special trades are about a particular security that someone needs, often for delivery against a short sale.

A harder one

A fund lends USD 50 million of cash for 7 days in a reverse repo on a specific on-the-run note at a special rate of 3.9%, when the GC rate is 4.5% (actual/360). Compared with lending the cash in the GC market, the fund's cost of borrowing the note is closest to:

  1. USD 70,000Why not: Scales the 0.6% annual spread by 7/30 (a month fraction) rather than 7/360.
  2. USD 37,917Why not: Computes the interest actually earned at the special rate, not the interest given up relative to GC.
  3. USD 833Why not: Uses one day of the spread; the trade lasts 7 days.
  4. USD 5,833 - correct

The fee for borrowing the special note is the interest forgone versus GC: 50,000,000 x (4.5% - 3.9%) x 7/360 = USD 5,833.

The hardest tier

Why can a special repo rate not normally rise materially above the GC rate?

  1. Central bank rules cap all repo rates at the policy rate.Why not: There is no such cap on repo rates; the limit comes from the owner's alternative of GC financing.
  2. Any owner can repo the security at the GC rate instead, so no one would pay more. - correct
  3. A specific security carries more credit risk, so cash lenders demand a lower rate.Why not: Specialness reflects demand for the security, not its credit risk.
  4. The special rate is defined as the yield of the security, which is always below GC.Why not: Special rates are not yields; they are financing rates set in the repo market.

Any holder of the bond can finance it at GC, as the bond works as GC collateral. Borrowers would never pay more than GC to lend the bond, so the special rate is at or below GC.

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