Fixed Income special, market, issues, 279

BC_MBA_student

Page 279, answer 5.a)

"One or more of the on-the-run issues may be on special in the repo market and thereby distort the true yield for these issues."

What is the repo market and how does it distort on the run issues?

Thanks

wxs1986

bump

I saw two questions on this in the EOCs, pls help!

bdavi77962

Repo market how I understand it: When you hold a long position in a bond, you are losing "opportunity cost" - meaning the money you used to buy this bond is not free. In order to pay for this positions, banks will "repo" out the security. They will borrow the money to hold the long position in the "repo" market and have the bond be the collateral for this money they borrowed.

The yield on the bond for the company holding the position will thus be: the return they are receiving for holding the bond, minus how much it costs to fund the position

Somebody out there - please correct me and expand.

Thanks!

mengxu

Repo market how I understand it: When you hold a long position in a bond, you are losing "opportunity cost" - meaning the money you used to buy this bond is not free. In order to pay for this positions, banks will "repo" out the security. They will borrow the money to hold the long position in the "repo" market and have the bond be the collateral for this money they borrowed.

The yield on the bond for the company holding the position will thus be: the return they are receiving for holding the bond, minus how much it costs to fund the position

Somebody out there - please correct me and expand.

Thanks!

ppls

A particular on-the-run issue may be used as collateral in the repo market (check econ section to learn about repo), therefore, it's price is a little distorted due to the high demand for it...i.e., don't use it when doing curve analysis.

ayaz_mahmud369

Thanks guys!

madaochenggong

essentially some funds always own the new on-the-run issue which meaning they have to sell the previous one upon a new issue (out of the repo market). since the latest off-the-run is being sold across the board the price drops below fair value (temporarily).