TAILIEUCHUNG - Special Repo Rates: An Introduction

This booklet explains how interest rates are calculated and the types of interest rates a consumer may encounter when dealing with financial service providers in Bahrain. Knowing about interest rates is important to consumers since it tells them how much it costs to borrow money and how much they can earn by depositing their money with a bank. Interest rates only apply to loans and deposits from conventional financial institutions. Islamic financial institutions do not charge or pay interest, but have other fees and payments not found in conventional institutions. This booklet looks only at interest rates in conventional banks. There is a Glossary at the back. | Special Repo Rates À An Introduction MARK FISHER The author is a senior economist in the financial section of the Atlanta Fed s research department. He thanks Jerry Dwyer Scott Frame and Paula Tkac for their comments on an earlier version of the article and Christian Gilles for many helpful discussions on the subject. The market for repurchase agreements involving Treasury securities known as the repo market plays a central role in the Federal Reserve s implementation of monetary policy. Transactions involving repurchase agreements known as repos and reverses are used to manage the quantity of reserves in the banking system on a shortterm basis. By undertaking such transactions with primary dealers the Fed through the actions of the open market desk at the Federal Reserve Bank of New York can temporarily increase or decrease bank reserves. The focus of this article however is not monetary policy but rather the repo market itself especially the role the market plays in the financing and hedging activities of primary dealers. The main goal of the article is to provide a coherent explanation of the close relation between the price premium that newly auctioned Treasury securities command and the special repo rates on those securities. The next two paragraphs outline this relationship and introduce some basic terminology that will be used throughout the article. Also see the box for a glossary of terms. 1 Dealers hedging activities create a link between the repo market and the auction cycle for newly issued on-the-run Treasury securities. In particular there is a close relation between the liquidity premium for an on-the-run security and the expected future overnight repo spreads for that security the spread between the general collateral rate and the repo rate specific to the on-the-run security . Dealers sell short on-the-run Treasuries in order to hedge the interest rate risk in other securities. Having sold short the dealers must acquire the securities via reverse .

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