The state in which a repo rate it is below the general collateral rate (GC rate). The difference between the general collateral rate (GC rate) and the special collateral rate (SC rate) is the repo spread:

Repo spread = GC rate – SC rate

If SC rate < GC rate, then the repo spread is positive and the collateral is said to be on special. The repo spread allows the holder of collateral to earn the so-called repo dividend.

Assume that δ is the repo dividend, i.e., the repo spread times the value of the collateral (e.g., a bond), r is the general collateral rate, R is the special collateral rate, p is the collateral’s value, and S is the spread:

δ= (r– R) × p = S × p

A dealer holding a given collateral on special (i.e., where its R < r) can earn the repo dividend, in the following steps:

• The dealer carry out a two-leg transaction: first, borrows the special collateral (i.e., the value of the collateral, p, at the special rate, R) and simultaneously lends a general collateral of an equal value at the general rate, r.
• The economic effect is a “zero” net cash flow and a “zero” net change in risk.
• Later on, the dealer unwinds both legs, receiving the special collateral back while paying [(1 + R) × p] and receiving [(1 + r) × p] in exchange for returning the general collateral.
• At the end, the dealer makes a net cash flow represented by the repo dividend [(r– R) × p].