A fail can occur on either the call-out or settlement date. PSA guidelines prohibit delivery of securities until two business days after pool information has been provided; if the dealer does not give ABC the pool information until August 15, settlement cannot occur until August 17. If the dealer fails to deliver the pools on time, it will make every effort to deliver them as soon as possible. If it cannot deliver the pools identified on the call-out date, it can substitute other pools, but it cannot deliver them until two business days after notifying ABC of the change. Meanwhile, ABC can use the money set aside for purchase of the security to generate short-term interest; the dealer must bear the cost of fail for each day it fails to deliver the security.2
2. Cost of fail: The opportunity cost of fund between the original and actual settlement dates, for which the buyer does not compensate the dealer.
If the dealer delivers the security after the record date, the dealer will receive the payment for August. If the security is delivered after the record date and before the payment date, the dealer must advance the monthly payment to ABC. If delivery occurs after both the record and payment dates, then the dealer must send the payment along with the security. Thus, in any fail scenario, ABC can earn short-term interest on the cash for purchase of the security at the expense of the dealer, and ABC earns monthly payments. In the rare instances of a fail, the buyer always comes out ahead.
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