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Please help me find the fault in my reasoning!

It seems to me that when a bond is trading special , it is in short supply and high demand , and so excessive number of people are borrowing money to buy it , and so these people would be willing to pay a HIGH interest rate (= repo rate) in order to get it.

But , the reasoning somehow should be that the repo goes DOWN when bond is special.

Please in your answer actually refute my above reasoning and also please explain without using unclear jargon.

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In repo/securities lending one person lends money (cash) and the other person lends securities. It is easier to understand if you think of the cash lender, who requires compensation for supplying the liquid asset (cash). If the cash lender supplies cash and receives ordinary ("general") collateral he receives one interest rate (usually clse to the FF rate), but if he insists on receiving a specific collateral which is scarce in the market ("special collateral") then he must accept a LOWER interest rate for lending his cash. At some point the "rebate rate" may even go negative, meaning the cash lender is actually paying interest to borrow the securities.

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  • $\begingroup$ To reiterate, repo, which is normally positive, is PAID by the lender of Securities and RECEIVED by the lender of Cash. When Lehman Bros. was financing itself on repo it was PAYING the repo rate to Money Market Funds who were borrowing its USTR securities and giving Lehman cash. (assuming the securities to be mostly General Collateral). $\endgroup$ – noob2 Mar 3 '17 at 15:48
  • $\begingroup$ It doesnt make sense... u r saying that the interest rate goes down because the collateral is now somehow even safer... in fact i would think that the price of the bond is very high and only going to go Down, so it is Not good collateral for the loan so should have a High interest rate! $\endgroup$ – Randor Mar 3 '17 at 17:48
  • $\begingroup$ I did not say anything about the safety of the collateral. Let's assume we are talking about USTR bonds that are perfectly safe, but one of them is "on special" because of a high demand to borrow it for delivery. $\endgroup$ – noob2 Mar 3 '17 at 18:17
  • $\begingroup$ U say the money lender is the one that insists on the collateral being special. That is strange, why would they do that $\endgroup$ – Randor Mar 3 '17 at 18:28
  • $\begingroup$ The m.l. says: I want 'USTR 1 5/8% of 05/2026' as collateral, please. The other guy looks at his sheet and says: 'you know that one is Special. It has been in very high demand the last few days'. He answers: yes I know, but this is the only collateral i want. The deal is then agreed at a special repo rate, which may be negative. $\endgroup$ – noob2 Mar 3 '17 at 18:46
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Treasury bonds go "special" when many participants want to short them (playing for s higher yield). The person who shorts the bond needs to deliver it to the counterparty, so must borrow that exact bond (versus investing cash) in the repo market. If lots of people want to do that , the repo rate goes down.

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theres high demand for the bond now , so spot price of bond goes high relative to fwd price of bond , therefore repo = carry goes down, even negative.

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