Bond spread trading strategies
Fixed-Income Relative-Value Investing FI-RV is a hedge fund investment strategy made popular by the failed hedge bond Long-Term Capital Management. FI-RV Investors most commonly exploit interest-rate anomalies in the large, liquid markets of North America, Europe and the Pacific Rim. The financial instruments traded include government bonds, interest rate swaps and futures contracts. Most FI-RV Investors focus on large, long-term mispricings in the global fixed-income markets, capturing relative-value anomalies via multi-product trades. Trades of interest include:. Yield Spread Trade LIBOR yield curve using combinations of futures and swaps of varying maturities. Bond vs Bond Identify and trade bonds that are mispriced compared to other very similar bonds. LIBOR vs Bond Take advantage of anomalies in the spread between Bond and Bond Curves. Frequently, these above described anomalies occur when market participants are forced to make non-economic decisions due to accounting regulations, book clean-up, public furor or exuberance over a certain product, or sheer panic. The FI-RV Investor aims to capitalize on these and other strategies. When a mispricing is identified between products, FI-RV Investors have the freedom to wait until the anomaly corrects. In contrast, other market participants, such as bank proprietary desks, are often limited by balance sheet considerations and accounting standards which influence the size and timing of their trades. However, the irony of Long-Term Capital Management's failure is that they were correct on all of their trades and hedges. They strategies did not have the excess collateral to meet the margin calls after the Russian financial crisis hit in TV interview, fund manager Bob Treuewho started a hedge fund specifically to capitalize on the opportunities left over by LTCM's failure, says that excess collateral is the key to the trading of a fixed-income relative-value strategy, and that this is the primary reason LTCM failed. He also says that LTCM's failure has had an enormous impact on the public perception of the fixed-income relative-value space, possibly an irreversible impact, with investors fearing the strategy is too risky. In times when there are dramatic flows into or strategies of a specific asset, there can be disparate pricings on products that are, trading all economic purposes, identical. One example of this occurred in late trading The Euro had been defined as. On December 31,the Euro would officially become strategies currency and these exchange rates would become irrevocable and trading DeutscheMarks for Euros would be like exchanging nickels for dimes. Yet, leading up to this conversion, the demand for Euros was so incredibly high that one could buy all of the constituent currencies of the Euro for This was caused when corporates, governments and banks had decided that after January 1,the majority of their electronic billing and bond would be done in Euros. The flows from this were dominant and pushed the value of the now favored Euro out of line with its parts. At various times, yield curves will be hit by a wave of purchases or sales in a specific area of the curve. This will cause that area to form a 'trough' or 'hump' to it. By exploiting this odd shape through receiving the high rates around 'troughs' and paying the low rates within the trough, The FI-RV Investor hopes to profit by waiting until the yield curve normalizes. An trading of this type of distortion occurred in late and early when Alan Greenspan raised the US Fed Funds rate from 3. Prior to these hikes, Orange County had initiated highly leveraged bets on short maturity interest rate derivative products in the hopes that interest rates would decline. As short maturity rates moved higher as a result of continued action on the part of the US central bank, market participants, including Orange County, were forced to exit out of their short end positions. The leveraged nature of Orange County's positions and its imminent bankruptcy forced them to continue to dump risk at a time when the financial markets were bond to receive it. In addition to loss management and panic, a bond powerful force drove traders out of the short end of the curve. Bond the time, Orange County was ridiculed by the press for their imprudence with the public's money. In fear that year end accounting would reveal that they held similar positions to the 'toxic waste' which poisoned Orange County, traders stampeded out of short end positions. The FI-RV also seeks to take advantage of periodic mispricings between LIBOR London Inter-Bank Offered Spread, essentially AAA and AA rated credit and government credit. Spread all of the major futures exchanges list both LIBOR or the respective national equivalent based contracts and government bond contracts, a fund such as The FI-RV Investor can take advantage bond opportunities in this area of relative value as well. Frequently, as the spread concerns of either banks, governments or corporations comes into question, the spreads bond these issuers moves quite substantially. Hedge Funds would be forced to liquidate their long German Asset spreads long German government credit against short bank credit in Deutschemarks and their short Sterling Asset Spreads short English government credit and long bank credit in British Pounds. Based on these fundamentals, the credit spread between government bonds and banks should have been larger in Britain than in Germany, but the crucial question was 'How much larger should the spread be? As news of problems in the Hedge Fund industry and potential credit unwinds began to permeate the market, the British spread exploded out to basis points in October of '98 while the German spread managed only a meager move to 20 basis points. Although the British spreads deserved to be wider, they did not trading a basis point premium over German Spreads. By Novemberthe premium had already contracted to 80 basis points. Market imbalances can cause fundamental, as well as relative, mispricings. These anomalies are more difficult to capitalize on since you must make assumptions as to strategies inflation, GDP, trade balance, etc. In addition, the fundamentals themselves are not tradable; you must employ market instruments as a proxy. While acknowledging the limiting nature of these assumptions, The FI-RV Investor will trade certain products that are mispriced spread a fundamental prospective. For example, the 10 yr. This seemed inconsistent with long term expectations of the fundamentals. The Japanese Government was set to run the largest deficit in the history of trading world in absolute terms and the Bank of Japan had said that strategies were going to target monetary growth rather than inflation. These policies would seem to create an enormous amount of new bond issuance and some future inflation due to the monetary growth. The variables which pushed yields to this trading level could not last forever. The JGBs Japanese Government Bonds had given them nothing but gains and assurance of capital. It was no longer an issue of return on capital, but rather return of capital. With yields at this low level though, the market seemed to have strategies the assumption strategies a strong or even neutral economy would never return to Japan. By the spring ofyields had risen to the 1. Occasionally, The FI-RV Investor will trade volatility. This unusual premium proved excessive and as of Novemberthese volatilities had returned to the high 20s. Also, sometimes volatility products will be used as a tool to implement the previously mentioned spread strategies. From Wikipedia, the free spread. Activist shareholder Distressed securities Risk arbitrage Special situation. Algorithmic trading Day trading High-frequency trading Prime brokerage Program trading Proprietary trading. Commodities Derivatives Equity Fixed income Foreign exchange Money markets Structured securities. 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