How Repo Rates Affect Bond Forward Prices and Financing Carry
Summary
This discussion explains why a higher repo rate can raise a bond’s forward price even when expensive financing might seem to make the bond less attractive. It distinguishes demand to borrow a bond from demand to sell it outright: high repo rates can reflect strong demand to borrow the security, for example to short it, and do not by themselves imply that its spot price must fall. Repo rates also reflect collateral supply and demand, including technical scarcity of high-grade bonds.
The pricing explanation is that a higher financing cost reduces the net carry from holding the bond, such as coupon income less repo financing. The forward price adjusts upward to account for that reduced carry. The discussion notes limits: repo rates are only one part of financing economics, collateral quality and haircuts matter, and repo rates have practical bounds set by funding costs. It does not provide a numerical example or quantify how much the forward price changes.
Key ideas
- A high repo rate can indicate demand to borrow a bond, rather than demand to sell it outright.
- Scarcity of high-grade collateral can affect repo rates for technical supply-and-demand reasons.
- Higher financing costs reduce the net carry from holding a bond and raise its forward price, all else equal.
- Collateral quality, haircuts, and funding costs also shape repo economics.
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Full text
# Why rise in repo rates leads to increase in forward bond prices? # Why rise in repo rates leads to increase in forward bond prices? Why repo rates increase is causing forward price of bond to increase. Confused with two arguments below ## Explanation 1 (Collaterizied loan) If repo rates are higher then it means that its very high rate of loan for this bond, or in other words the bond is not in much demand. This suggests that price should be cheaper. Same goes for forward price then. ## Explanation 2 If repo rates are higher, i will try to profit from that (from perspective of reverse repo counterparty) by buying the bond in first leg and gaining repo rate in the next leg of the transaction when i sell the bond back. Not entirely convincing argument here, but in the next leg of the transaction i should make a loss as high repo rate is giving me good profit. *Assuming all market participants are capturing this high repo rate and buying in the spot market. This should drive up spot price of the bond in short term and hence the forward price. ## Answer by Lliane (score 3) https://quant.stackexchange.com/a/43006 These types of quantitative explanations always exclude the economic side effects you are mentionning, it's like saying the future price is higher when interest rates raise (of course the spot might drop when interest rates are raised by the FED but that's not the point) > If repo rates are higher then it means that its very high rate of loan for this bond, or in other words the bond is not in much demand. If the repo rate is high, it means there is a lot of demand for lending the bond to get financing relative to the demand for borrowing the bond. You seem to conflate demand for selling the bond outright with demand for lending the bond, which are two completely different notions. You might lend a bond as collateral (which will not drive the spot price of the bond) or because you give access to a hedge fund who wants to short the bond. There are two different reasons why there could be lower repo rates, the economic justification is different but it's all about offer and demand. - There can be lower repo rates on high grade bonds (if there are too few high grade bonds available on some markets compared to the demand for collateral) for purely technical reasons. - There can be lower repo rates on junk bonds because hedge funds want to borrow and short sell them. Please note that repo rate is not the only thing that matters, if you give junk collateral you will likely experience a heavy haircut, and for the worst issuers no one will want to lend you cash on your bonds (except short sellers) so the repo rate becomes irrelevant. The repo rate is kind of capped on the high side, because there's no point repoing a bond if you get cash at a higher rate than your own cost of funding. ## Answer by VanillaCall (score 2) https://quant.stackexchange.com/a/43040 Higher repo rates suggest higher costs to finance the bond position over some horizon period. This reduces the net carry you earn (coupon less financing cost). The forward price increases to adjust for the reduced net carry so an investor needs the spot price to rise above the forward price to make money. If the forward price is realized, the investor breaks even
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