Bond Trading
Bond trading strategies that involve cash bonds and/or CDs can, at times, be highly linked to repo. An example of that linkage would be outright short selling. A dealer may deliberately sell a bond it does not own, anticipating that the price will fall at a future date, at which time the bond will be purchased for a profit. Alternatively, the dealer may just sell a bond it does not own in its market-making capacity. In either case, on settlement day the buyer expects delivery of the bonds.
If the dealer does not already own the bond then they are faced with a choice of failing to deliver the bond, borrowing the bond from an automatic facility (such as Euroclear or Clearstream) or going into the repo market. The preferred method is the repo market since the repo trades settle DVP (same as outright trade) and there are no expensive intermediary (the automatic borrowing facility) taking a spread. Furthermore, the dealer can lock in borrowing for different duration as suits him.
Another example would be hedging. Most financial institutions hedge at least a portion of their bond portfolio. Positions can be hedged via futures or options but in some cases, there is no suitable derivative instrument. For instance, a bond dealer wishing to hedge a seven-year security would have significant yield curve risk unless another seven-year instrument was shorted. Hence, shorting securities generates demand for repo.
