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1.
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Definition
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Fixed income arbitrage attempts to
capture mispricings which develop between related classes of fixed
income securities — mispricings which may be exploited, on a
leveraged basis, for significant returns. This general strategy
type includes basis (e.g., cash vs. futures), yield-curve and credit
spread trading, as well as volatility arbitrage. An unusually high
degree of leverage is often available, and often emphasized, in
fixed income arbitrage.
Other Resources:
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The Free Dictionary:
An investment strategy that attempts to profit from arbitrage
opportunities in interest rate securities.
More…
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Wikipedia:
Fixed-income
arbitrage is an investment strategy generally associated with
hedge funds, which consists of the discovery and exploitation of
inefficiencies in the pricing of bonds, i.e. instruments from
either public or private issuers yielding a contractually fixed
stream of income.
Most arbitrageurs who employ this strategy trade globally.
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Eden Rock Capital
Management:
Fixed income arbitrage involves a wide spectrum of strategies
across all types of interest-rate related securities ranging
from corporate and government debt to swaps and futures.
More…
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Fund.com:
This
style aims to profit from price anomalies between related
interest rate securities. Most managers trade globally with a
goal of generating steady returns with low volatility.
More…
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Hedge Fund Japan:
Purchase bonds and short
instruments that replicate bond. Strategy aims to profit from
mispricing between the two sides.
More…
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2.
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Examples, Types, or
Variations
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In
pursuit of their goal of both steady returns and low volatility, the
arbitrageurs can focus upon interest rate swaps, US non-US
government bond arbitrage, see US Treasury security, forward yield
curves, and/or mortgage-backed securities.
The two main
categories of Fixed Income Arbitrage are:
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Relative Value: Construction of a diversified portfolio with the
goal of maximizing return and minimizing risk.
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Market Neutral: Minimizing risk by taking long and short
positions and maximizing return by taking advantage of pricing
anomalies between sectors in the Fixed Income market.
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3.
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Formula
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4.
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Related Terms
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5.
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As
Used in the Hedge Fund World
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6.
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Applications
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7.
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Misused
& Abused
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Long-Term Capital Management (LTCM) lost U.S. dollars 4.6
billion in fixed income arbitrage in September 1998. LTCM had
attempted to make money on the price difference between
different bonds. For example, it would buy U.S. Treasury
securities and sell Italian bond futures. The concept was that
because Italian bond futures had a less liquid market, in the
short term Italian bond futures would have a higher return than
U.S. bonds, but in the long term, the prices would converge.
Because the difference was small, a large amount of money had to
be borrowed to make the buying and selling profitable.
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8.
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Additional Sources of Information
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Books
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News
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Scholarly Papers
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Back to Terms
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