How Repo Funding Costs Work for Long and Short Bond Positions

# What are the practical costs of repo for a bond trading desk?


# What are the practical costs of repo for a bond trading desk?












I appreciate what a repo/reverse repo transaction is, but I'm struggling to understand exactly how the cost of funding trades via repo works from a practical point of view for a bond trader.

Current understanding





In summary, going long results in funding costs because of repo, and going short results in gains because of repo.

Issues with (1)

Why do calculations for financing long positions of a security (call it security $A$) necessarily involve the repo rate for bond $A$? Could you not similarly use the repo rate of any other bond that the desk owns? In fact, it seems to me that you should use the repo rate of a different bond, since if you could use that bond to obtain cash via repo, you wouldn't need to buy it in the first place.

Issues with (2)

Where does the cash used to enter the initial repo transaction (the one via which the security is obtained) come from? If they have this cash to enter repo transactions to cover short positions, then why don't they just use this cash to go long rather than financing long positions via repo?

Desired answer

- Is my initial understanding of going long/short via repo correct?

- What about issues (1) and (2) is incorrect?

- Can you give a description of the transactions a bank undergoes in explaining where my misunderstanding lies?

## Answer by xing gao (score 2, accepted)

https://quant.stackexchange.com/a/61438

- Yes. Repo trades are funding source for long bond, while reverse repo trades are security borrowing source for short bond.

- Issues 1. In reality, you cannot just fund your long bond A by repo trade with A only, because there will be haircut in repo. For example, you can only borrow 85% cash for high yield bonds, maybe 95% for investment, and 98% for treasury notes. Considering each bond may have its own haircut ratio, you must link the bond with its own repo trade. And there are also cashflow issues, such as coupon payment. Issues 2. Trades are simultaneously done. Trader will set them at the same settlement date. Theoretically you won't need to pay extra funding cost if every thing goes smoothly. If not, you could probably claim interest from your faulty counterparty.

- If the market has central clearing service or you can even buy the bond and do repo trade with the same counterparty, the receivables and payables will be matched and sometimes net settled. Thus no need to worry about the timing difference.