General collateral securities

This is part of the general collateral (GC) market, and is more common in the United States than elsewhere. Consider the case of a cash-rich institution investing in GC as an alternative to deposits or commercial paper. The better the quality of collateral, the lower the yield the institution can expect, while the mechanics of settlement may also affect the repo rate. The most secure procedure is to take physical possession of the collateral. However, if the dealer needs one or more substitutions during the term of the trade, the settlement costs involved may make the trade unworkable for one or both parties. Therefore, the dealer may offer to hold the securities in his own custody against the investor s cash. This is known as a hold-in-custody (HIC) repo. The advantage of this trade is that since securities do not physically move, no settlement charges are incurred. However, this carries some risk for the investor because they only have the dealer s word that their cash is indeed fully collateralised in the event of default. Thus this type of trade is sometime referred to as a Trust Me repo it is also referred to as a due-bill repo or a letter repo. 

In the case of a bonds borrowed/collateral pledged trade the institution lending the bonds does not want or need to receive cash against them, as it is already cash rich and would only have to reinvest any further cash generated. As such this transaction only occurs with special collateral. The dealer borrows the special bonds and pledges securities of similar quality and value (general collateral). The dealer builds in a fee payable to the lending institution as an incentive to do the trade. 

However, the repo desk has lent 937,708 against this security, which exceeds its market value. Under a variation margin arrangement it can call margin from the counterparty in the form of general collateral... 

TR swaps may also be used for speculation. Bond traders who believe that a particular bond not currently on their books is about to decline in price have a couple of ways to profit from this view. One method is to sell the bond short and cover their position through a repo. The cash flow to the traders from this transaction consists of the coupon on the bond that they owe as a result of the short sale and, if the shorted bond falls in price as expected, the capital gain from the short sale plus the repo rate—say, LIBOR plus a spread. The danger in this transaction is that if the shorted bond must be covered through a repo at the special rate instead of the higher general collateral rate—the one applicable to Treasury securities— the traders will be funding it at a loss. The yield on the bond must also be lower than the repo rate. 

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