Repo & Financing
The plumbing of fixed income markets-where $4 trillion changes hands every night.
When the Plumbing Breaks
On September 17, 2019, overnight repo rates spiked from 2% to 10% in a matter of hours. The borrowing rate for "risk-free" Treasury collateral quintupled.
Banks stopped lending. Dealers couldn't finance their inventory. Hedge funds scrambled to roll positions. The Federal Reserve-which hadn't intervened in repo markets since 2008-was forced to inject $75 billion in emergency liquidity.
This wasn't a financial crisis. There was no credit event. Just a plumbing problem: too many payments going out, not enough reserves to fund them. Yet it nearly froze the Treasury market-the foundation of global finance.
Repo is how the fixed income world gets funded. Every leveraged bond trade, every dealer inventory position, every hedge fund basis trade-all financed through repo. Understand repo, and you understand why positions live or die.
Learn From History
Select a repo market event to see how financing stress shaped trading outcomes:
September 2019 Repo Spike
The Setup
Corporate tax payments drained $35B from reserves. Treasury settlement drained another $54B. Banks hit regulatory constraints and couldn't lend.
What Happened
Overnight repo rates spiked from 2% to 10% in hours. Some trades printed at 9%+. The Fed hadn't intervened in repo since 2008. They scrambled to inject $75B in emergency liquidity.
What is Repo?
A repurchase agreement (repo) is a collateralized loan. You sell securities today and agree to buy them back tomorrow (or next week, or next month) at a slightly higher price. That price difference is the interest you pay.
Day 1: You Need Cash
You "sell" $10M of Treasuries to a repo counterparty. They give you $9.8M cash (98% of value-the 2% difference is the haircut).
Day 2 (or Later): You Buy Them Back
You "repurchase" your bonds for $9.8M + interest. At 5% overnight repo, one day costs about $1,300. You get your bonds back.
Overnight Repo
Most common. Rolled daily. Rate floats with Fed Funds. About 70% of all repo is overnight.
~$3T dailyTerm Repo
Fixed rate for 1 week to 3 months. Used when you want certainty or expect rates to rise. Slightly higher rate than overnight.
~$1T outstandingGeneral Collateral (GC) vs Specials
Not all bonds repo at the same rate. This distinction is crucial for carry calculations.
General Collateral (GC)
Currently: ~5.30%
- Average rate for "any Treasury will do" collateral
- Tracks Fed Funds closely (usually within 5-10 bps)
- Off-the-run bonds trade at GC
- This is your baseline financing cost
Specials
Can be: 0% to GC-200bps
- Specific bonds that trade below GC
- High demand from shorts drives rates down
- On-the-run bonds often trade 20-100 bps special
- Lenders accept lower rate to get specific collateral
Why On-the-Run Goes Special
The newest ("on-the-run") 10-year Treasury is the most liquid. Everyone uses it for hedging. If you're short, you need to borrow it to deliver. That borrowing demand pushes the repo rate down-sometimes to zero or even negative (you pay to lend cash!).
Reverse Repo: How You Short Bonds
If repo is borrowing cash against bonds, reverse repo is the mirror image: you lend cash and receive bonds as collateral. This is how you get bonds to short.
Borrow the Bond
You enter a reverse repo: give $10M cash to a counterparty, receive $10M of 10Y Treasuries as collateral.
Sell the Bond Short
You sell the borrowed bonds in the market. Now you're short. You pocket the sale proceeds.
Close Out
Later, buy bonds back in market (hopefully cheaper), return them to counterparty, get your cash back plus interest earned.
Economics of Shorting via Reverse Repo
When you're short:
- You earn: Interest on the cash you lent (the repo rate)
- You owe: Any coupon payments during the borrow period
- You hope: Bond price falls so you can buy back cheaper
If the bond goes special, your cost to borrow it rises-and your negative carry gets worse. This is why shorts sometimes get "squeezed" when everyone rushes to cover.
The Leverage Calculation
Repo creates leverage. Here's the math that every fixed income trader knows by heart:
With 2% haircut, every $1 of your money controls $50.0 of bonds. A 1% move in bond prices = 50.0% move in your equity.
Typical Haircuts by Collateral
Build a Repo-Financed Position
Trade Legs
Combined Position
Payoff Profile
P&L across parallel yield curve shifts (all tenors move equally):
Risk Summary
Position is long duration (+$8K DV01). Profits when rates fall, loses when rates rise.
Trade Examples (Simple)
Here's how repo financing works in practice-explained clearly:
Example 1: Financing a Long Position
You want to buy $10M of 10-year Treasuries yielding 4.4%. You have $500K in capital.
You put up your $500K as margin (5% haircut). You repo-finance the other $9.5M at 5.3% GC rate. The bonds serve as collateral-if you default, the repo counterparty keeps them.
You earn: 4.4% coupon on $10M = $440K/year
You pay: 5.3% repo on $9.5M = $504K/year
Net carry: -$64K/year (negative carry)
You're paying to hold this position because financing costs more than the coupon. You need rates to fall (bond prices up) to make money. With 20x leverage, a 50bp rate drop = 10% gain on your $500K equity ($50K). That's about 9 months of negative carry.
Example 2: Shorting a Bond via Reverse Repo
You think rates will rise. You want to short $10M of 10-year Treasuries.
You enter a reverse repo: lend $10M cash, receive $10M bonds as collateral. You immediately sell those bonds in the market. Now you have $10M cash from the sale + you'll get interest on your $10M repo loan. But you owe the coupon to whoever you borrowed from.
You earn: 5.3% on $10M repo = $530K/year
You owe: 4.375% coupon on $10M = $437.5K/year
Net carry: +$92.5K/year (positive carry!)
With an inverted curve, shorts earn carry! You get paid to wait for rates to rise. If the 10Y bond goes "special" though (lots of shorts competing to borrow it), your repo rate falls and carry shrinks.
Example 3: The Carry Trade Funding Math
It's 2021. Repo is 0.05%. The 10Y yields 1.5%. You go long $100M with 2% haircut ($2M equity).
You finance $98M at 0.05%. Your financing cost is basically zero ($49K/year). Meanwhile, you earn 1.5% coupon on $100M = $1.5M/year. That's $1.45M profit on $2M equity = 72% return.
This worked beautifully until the Fed hiked. Repo went to 5%+. Suddenly financing $98M costs $4.9M/year vs $1.5M coupon income. The trade went from +72% to -170% annual return.
Leveraged carry trades print money when the curve is steep and rates are stable. They become toxic when the Fed hikes. The leverage that made 72% gains possible also created 170% losses.