Assume I want to short a bond. What is the "cost" of doing that? Example: I borrow 100 and lend it to another bank that delivers me a bond worth 100 in a repo contract. I then sell the bond, receive 100 in cash and pay back the initial loan. I now have 1) a short position in the bond and 2) receive interest income on the cash deposited in the repo transaction. It seems to me like a have a positive carry (I receice income in the repo) on this position... Is this correct?

You also will pay for the use of the bond. this will depend on whether the rate is GC (General Collateral) or Special.

Ok but special rates just mean that the cash in the repo accrues at a rate lower than GC. But in my example that only means that you receive less on the cash in the repo, you still have a positive net interest income. Is this correct?If it is correct then there is no cost associated with going short a bond.

A bit more complex than that:Initial Flows:Borrow bond value + haircut from treasury/streetBorrow 100 bond, lend 100 bond + haircut (normally about 105% ) cashSell 100 bond raise 100 cashRepay 100 cash to treasury street (you are still going to have to borrow the hair cut though)Then cashflows during deal:Pay interest on haircut to treasury/streetPay Fee on RepoReceive Rebate on cash on repoFee will be based on whether bond is GC or specialOn unwind (assuming market bond price has not moved):Borrow cash from treasury/streetBuy back BondDeliver bond on repoReceive cashPaypack treasury/street

Thanks! But we run into several assumptions here that makes the net effect very hard to determine. My basic question still stands: is there a cost of shorting a bond (or is there a gain)? Possibly the answer is: it depends...

Erm, what about the coupon?

right.. the bond has positive theta (positive time value). shorting a bond ought to be going against this. is this a factor that I have omitted? if so how will this affect the cost of shorting?

I don't know nuthin' about no theta. All I'm sayin' is that the bond will be accruing during the period you're short it and you should take that into account.

Think about buying a bond and repoing it out.You earn the accrual on the bond and pay the repo rate for the cash.This is the opposite of that.

Thanks! Yes you have to pass on the coupon to the original owner. To the extent that is higher than the rate earned on the cash in the repo you have a cost. Thank you very much for helping me with this!

When traders talk about bonds, is carry just another relative value measure?I assume cost of carry is defined as cost of funding (say GC rate or repo rate) - bond yield (Accrual).So wouldn't that mean almost all bonds now have positive carry?Low rates generate demand for all assets.. In a way there is a natural flattening bias on the yield curve.Could anyone recommend or have any recent papers on bond RV analysis ..thanks

Yes... I assume you have read the Antti Ilmanen papers?

Hi everybody!! I opened again this thread because I would like to know more about shorting a bond, I read the answer of rmax, but I cannot understand why do I have to borrow 100 + haircut, if I am the party that receives the "special" collateral. I though that, the party that delivers the "special" bond as collateral, will receive less money from me than the market value of the bond.The haircut should be a factor in my favor. Am I wrong?! Thanks a lot in advance!!QuoteOriginally posted by: rmaxA bit more complex than that:Initial Flows:Borrow bond value + haircut from treasury/streetBorrow 100 bond, lend 100 bond + haircut (normally about 105% ) cashSell 100 bond raise 100 cashRepay 100 cash to treasury street (you are still going to have to borrow the hair cut though)Then cashflows during deal:Pay interest on haircut to treasury/streetPay Fee on RepoReceive Rebate on cash on repoFee will be based on whether bond is GC or specialOn unwind (assuming market bond price has not moved):Borrow cash from treasury/streetBuy back BondDeliver bond on repoReceive cashPaypack treasury/street

There was also a pretty good article written about Robert Citron's repo shenanigans while he was Orange County treasurer. I have the article, if you drop me a pn with your email I can send you a copy of it.In any case, in a true transaction like this you would never outright sell the bond, as you would have to procure it at some point to return to Bank B if they decide to not roll their repo and unless it's a dollar roll on RMBS, you have to provide the exact same bond (unless they agree to a substitution in case you fail to deliver). Failure to deliver out of these transactions can be kind of expensive in the end (I've seen it happen a few hundred times).You would end up receiving the repo rate +/- interest from the bond (which you have to pass on to Bank B) +/- whatever accrued interest you have from the loan. So depending on how your lending rate is and the current state of interest rates, you might be in plus or you might be in negative. It's always dependent on market factors.If you take a haircut in the repo (you give out less cash than you receive in bond collateral - i.e. you give out 70 in cash and receive 100 in bond collateral) then it is in your favor, that is correct.

Thanks Chargerbullit! I send you a pm, it would be great to read that article!So your point is that, I still need to borrow the money from bank C, in order to lend the money to B, who gives me the "special" collateral, which I sell to the market. Although I don't sell the bond directly, at some point I have to sell it, otherwise what is the point of this whole transaction?!What I am trying to do here is to arbitrage a positive CDS bond basis, including all the costs that rise in reality. Now I am working on "shorting the bond" part of the trade, in another post in the Trading forum I asked about "selling protection on the CDS".