What it means
In a securities loan, the borrower usually gives the lender cash as collateral, often worth slightly more than the shares borrowed. The lender invests that cash, for example in short-term money market instruments, and earns interest.
The lender then returns most of that interest to the borrower as the rebate. The rebate rate is what is left after the lender takes its fee.
A borrower of easily found shares might receive a rebate close to the prevailing short-term interest rate, because the fee is small. A borrower of scarce shares receives a much lower rebate, since the lender keeps more.
This structure means the true cost of borrowing shares is the difference between the interest rate on the cash and the rebate rate. Traders often quote the rebate rather than the fee, and a negative rebate signals that the shares are very hard to borrow.
The borrower has to pay money to the lender to keep the loan going. For non-specialists, the rebate is a way of seeing that stock lending is a financing arrangement as well as a share transaction.
Cash goes one way, shares go the other, and interest flows back in return. This is why prime brokers (the banks that serve hedge funds) and custodians keep detailed daily records of every loan.
The rebate is also a reason why short sellers care about interest rates. When rates are high, the rebate on easy-to-borrow shares is attractive and helps offset the cost of a short position.
When rates are near zero, there is little interest to rebate, so the fee takes up a bigger share of the cost.
In practice
Real-world examples.
Example
A hedge fund shorts a large pharmaceutical company and posts $1,000,000 of cash collateral. The lender earns 4% and charges a 0.25% fee, so the fund receives a rebate rate of 3.75%. That equals about $37,500 over a full year, which offsets part of its financing costs.
Example
A trader shorts a thinly traded biotech stock where the fee is 12% and the cash earns 4%. The rebate rate is negative 8%, which means she pays $8,000 a year for every $100,000 of collateral. She decides the cost is too high and reduces the position.
Example
An asset manager lending shares from a fund reviews the programme's income. Most of the earnings come from a small number of hard-to-borrow stocks with low rebates. The manager sets stricter rules on collateral quality so the extra income does not bring in more risk.
Formula
Calculation
Rebate rate = interest rate earned on cash collateral - stock loan fee rate
Rebate paid = cash collateral x rebate rate x (days / 360)
A borrower posts $200,000 of cash collateral for a 30-day loan. The lender earns 4.5% a year on the cash, and the stock loan fee is 1.5%. Rebate rate = 4.5% - 1.5% = 3.0%. Rebate paid = 200,000 x 0.03 x (30 / 360) = 6,000 x (30 / 360) = $500. If the fee were 6% instead, the rebate rate would be 4.5% - 6.0% = -1.5%, and the borrower would owe the lender.Case study
Seen in the real world.
Calder Street Capital is an illustrative, fictional hedge fund that shorts $10,000,000 of a mid-sized consumer company. It posts cash collateral of $10,000,000, which the lender invests at 5% a year, and the fee on the shares is 0.5%.
The rebate rate is therefore 4.5%, and over a 90-day holding period the fund receives 10,000,000 x 0.045 x (90 / 360) = $112,500. The fund's analyst records this as financing income against the cost of the position.
Then the company announces a surprise acquisition, demand to short the shares dries up and the fee falls to 0.25%, so the rebate rises. The illustrative lesson is that the rebate is a moving number, and a fund should update its profit forecast whenever either the interest rate or the borrow fee changes.
Watch out
Common mistakes.
- Thinking the rebate is a bonus paid for lending, when it is the borrower who receives it as interest on the collateral they posted.
- Ignoring a negative rebate, which signals that the borrower is paying extra to hold the position.
- Mixing up the rebate rate and the loan fee, when the first is the interest returned and the second is the charge the lender keeps.
Questions
People also ask.
Who pays the rebate?
The lender pays it to the borrower, from the interest the lender earns on the cash collateral.
What does a negative rebate mean?
It means the fee exceeds the interest earned on the cash, so the borrower has to pay the lender the difference to keep the shares.
Is a rebate paid on non-cash collateral?
Usually not, because when the collateral is other securities there is no cash interest to return, and the borrower instead pays a straight fee.
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