Let's take a look at the repo rate.

The repo rate is the agreed upon interest rate that the borrower pays on the cash provided in a repurchase agreement.

This rate is generally lower than unsecured borrowing rates as the collateralized nature of repos reduces the lender's risk, and the spread between the uncollateralized borrowing rate and the repo rate is influenced primarily by two factors, the credit quality of the collateral and the supply and demands dynamics for that collateral in the repo market.

Let's break down these factors in terms of general collateral and special collateral, along with additional nuances that influence repo pricing.

In cash driven transactions, where the main objective is to borrow or lend cash, the lender is typically indifferent about the specific bond received as collateral, provided it meets certain credit and liquidity standards.

This is known as general collateral because the specific bond isn't as important as its general quality.

Typically, there's one repo rate for government bonds from the same issuer known as the general collateral rate.

This rate reflects the general market demand for cash rather than for specific securities.

When a specific bond is in high demand in the repo market, this bond becomes special.

This demand could be due to scarcity, market conditions, or other specific needs, making the transaction security driven rather than cash driven.

In such cases, the bond is said to trade special.

Since there's a premium for borrowing this specific issue, the repo rate for special collateral is often lower than the general collateral rates.

This lower rates reflects the premium associated with accessing this highly sought after bond in the repo market.

Beyond the basic distinction between general and special collateral, repo rates can also vary depending on the term of the agreement.

While overnight repos are the most common, term repos where the borrowing period is longer can carry slightly higher rates to account for the extended duration.

This is influenced by market liquidity and expectations for future interest rates, and it's particularly relevant for those looking at repo markets over various time horizons.

Additionally, while government bonds are often used as repo collateral, other securities such as corporate bonds or mortgage-backed securities can also serve this purpose.

These assets typically carry more credit risk than government bonds, which means that repos backed by such collateral generally have higher rates to reflect the added risk.

This is an important distinction for participants considering repos outside of the government bond market as the collateral type significantly impacts the repo rates.