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FRM Part II · FRM Exam Part II · Repurchase Agreements and Financing

A trader needs to cover a short position in a specific Treasury bond that is trading with a repo rate well below the general collateral (GC) rate. What does this indicate about that bond?

A repo rate well below the GC rate means the bond is trading special. Demand to borrow that specific security is high, so the party lending cash to get it accepts a lower rate. The borrower of cash against the bond therefore finances cheaply.

  1. AThe bond is trading special, because demand to borrow it is high, so cash lenders accept a lower rate to obtain itCorrect
  2. BThe bond is trading at a premium to par, so its repo rate must always be lower
  3. CThe bond has a larger haircut than other collateral, so the cash lender charges less
  4. DThe bond is illiquid, so lenders demand a higher rate than GC

Explanation

When a security is in high demand, those who lend cash against it (reverse repo) will accept a lower interest rate in return for obtaining the specific bond. The bond is said to be on special, with a repo rate below GC. A haircut or illiquidity would raise, not lower, the rate.

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