LO 51.5: Compare the use of general and special collateral in repo transactions.

LO 51.5: Compare the use of general and special collateral in repo transactions.
Repo trades can be secured either with general collateral or with specific (i.e., special) collateral.
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Topic 51 Cross Reference to GARP Assigned Reading – Tuckman and Serrat, Chapter 12
General Collateral
While lenders care about the quality of collateral delivered, under general collateral (GC), repo lenders are not concerned with receiving a particular security or class of securities as collateral. Instead, only the broad categories of acceptable securities are specified. The logic here is that when lenders are looking to receive a specific rather than generic security as collateral, this creates a demand for that security and lenders have to accept a lower return on the repo trade. GC trades suit investors in repos because they can obtain the highest repo rate for the collateral received.
The repo rate for trades secured with general collateral is called the GC rate. GC rates can be used for repos with U.S. Treasury collateral, and the overnight rate for U.S. Treasury collateral is referred to as the GC rate. In the United States, the GC repo rate is typically slightly below the federal funds rate, although repos with U.S. Treasury collateral are considered safer and in fact can trade below the federal funds rate. The difference between the federal funds rate and the GC rate is measured through the fed funds-GC spread. This spread widens when Treasuries become scarcer (the GC rate falls) or during times of financial stress, as was the case during the recent financial crisis.
Professors Note: The fed era l funds rate is an interest rate that depository institutions in the United States charge each other fo r lending funds m aintained at the Federal Reserve.
Special Collateral
When lenders are concerned with receiving a particular security as collateral, the collateral is referred to as special collateral, and the repo trade is called a specials trade. If you recall our discussion on financing as a motivation for repo lending, it should be clear that specials trades are particularly important in financing transactions used to obtain specific bonds. The repo rate for trades secured with special collateral is called the special rate.
In specials trading, the lender of cash is concerned with receiving a particular security in order to finance the purchase of a bond (for shorting), or to finance its inventory or proprietary positions. Lenders accepting special collateral face a trade-ofF between receiving the desired security and lending at below GC rates to receive the desired security. Special rates differ by security because there is a rate for each security for each term. Special rates are determined by market supply and demand; however, it is important to note that the supply and demand of the underlying security is not the same as the supply and demand of the specials trade itself. In fact, a bond that is in high demand in the market may not be in great demand as collateral for a specials trade. The reverse could equally be true.
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2018 Kaplan, Inc.
Topic 51 Cross Reference to GARP Assigned Reading – Tuckman and Serrat, Chapter 12
S p e c i a l S p r e a d s a n d t h e A u c t
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