Arbitrage in the US Treasury Market?

Slides:

Advertisements

Similar presentations

1 Financing Techniques for Short Sellers Stuart McCrary.

Advertisements

Term Structure of Interest Rates. Outline  Meaning of Term Structure of Interest Rates  Significance of Term Structure of Interest Rates  What is Yield.

Intro to Financial Management Financial Markets and Interest Rates.

11-Interest Rate Risk. Review  Interest Rates are determined by supply and demand, are moving all the time, and can be difficult to forecast.  The yield.

Interest Rate Swaps and Agreements Chapter 28. Swaps CBs and IBs are major participants  dealers  traders  users regulatory concerns regarding credit.

Characteristics of Taxable Securities Money Market Investments Highly liquid instruments which mature within one year that are issued by governments and.

An Overview of the Financial System chapter 2. Function of Financial Markets Lenders-Savers (+) Households Firms Government Foreigners Financial Markets.

The Term Structure of Interest Rates

Duration and Yield Changes

Bonds with embedded options

US Treasury Securities Backed by full faith and credit of the US government, hence free of credit risk Highly liquid instruments, $4T T-bills (Zero Coupon):

Drake DRAKE UNIVERSITY Fin 284 Bonds with embedded options.

Bonds are typically priced “relative” Generally: Lower quality is priced relative to higher quality Lower liquidity is priced relative to higher liquidity.

Our market “risk” Measure Position adjusted sensitivity using 1 basis point change Example of “bond risk”: Price (pv): (that’s a total amount.

Lottery Problem A state run monthly lottery can sell 100,000tickets at $2 a piece. A ticket wins $1,000,000with a probability , $100 with probability.

Yield Curves and Term Structure Theory. Yield curve The plot of yield on bonds of the same credit quality and liquidity against maturity is called a yield.

Personal Finance. Make saving a priority in your money routine: First decide how much you can save each month. Each pay period, pay yourself first. Next.

Chapter 5 Determination of Forward & Future Prices R. Srinivasan.

VALUATION OF BONDS AND SHARES CHAPTER 3. LEARNING OBJECTIVES  Explain the fundamental characteristics of ordinary shares, preference shares and bonds.

"We firmly believe that the on-the-run issues should command a high liquidity premium in the current environment. But with very high probability, the.

Introduction to Derivatives

Comm W. Suo Slide 1. comm W. Suo Slide 2  Active strategy Trade on interest rate predictions Trade on market inefficiencies  Passive.

Outline o What they are o How they work o Who uses them o History ?

1 Bond Portfolio Management Term Structure Yield Curve Expected return versus forward rate Term structure theories Managing bond portfolios Duration Convexity.

Yield Curve and Term Structure of Interest Rate. Base rate of interest –US Treasuries are “safer” than any other (US) debt security free of credit risk.

Chapter 6 Treasury Securities Markets. Treasury Securities Backed by full faith and credit of U.S. government Zero default risk Largest volume of any.

SWAPS Types and Valuation. SWAPS Definition A swap is a contract between two parties to deliver one sum of money against another sum of money at periodic.

STRIPS -Separate Trading of Registered Interest and Principal Securities” Presented by Group 5.

© 2012 McGrawHill Ryerson Ltd. Chapter 6 -  A graph of the relationship between time to maturity and yield to maturity, for bonds that differ only in.

Comm W. Suo Slide 1. comm W. Suo Slide 2  Active strategy Trade on interest rate predictions Trade on market inefficiencies  Passive.

Bond Price Volatility Chapter 4.

1 Business F723 Fixed Income Analysis. 2 Plain Vanilla Bond Issuer Maturity Date Face Value ($1,000) Coupon Rate (paid 1/2 every six months) Financial.

Financial Risk Management of Insurance Enterprises Review of Bond Pricing.

Quiz 1 – Mythical Man-Month Chapters 1-6. Topics for today Review our market risk measure Review units Negative position amounts – shorting Relative Pricing.

Interpreting Stock Data on the Internet Stock Market Game.

082SIS52 Ryu Soo-hyun. Money Market  Money Market - Subsection of fixed income market - financial market for short-term borrowing & lending - provides.

F9 Financial Management. 2 Designed to give you the knowledge and application of: Section H: Risk Management H1. The nature and type of risk and approaches.

Fixed income securities valuation Spot rates and forward rates and bond equivalent yields 1.

Securities Analyst Program

Assignment tips.

BASIC MATHS FOR FINANCE

Topic 6: Interest Rates Session 6A&B Course Director:

Chapter Twenty Two Futures Markets.

Chapter 5 Determination of Forward and Futures Prices

Chapter 6 Learning Objectives

Understanding Policy Measures

Debt underwriting and bond markets

Determination of Forward and Futures Prices

The Term Structure of Interest Rates

9. Other Risks and the Value of Cash Flows

The term structure of interest rates

Fi8000 Valuation of Financial Assets

The Term Structure of Interest Rates

Futures Markets and Risk Management

Interest Rate Risk Chapter 9

Arbitrage in the US Treasury Market?

Economics 434: The Theory of Financial Markets

TYPES OF FINANCIAL ASSETS

The Term Structure of Interest Rates

FIN 377: Investments Topic 5: The Term Structure of Interest Rates

The Term Structure of Interest Rates

Bonds and interest rates

Intro to Financial Management

Chapter 5 Determination of Forward and Futures Prices

Hu - Financing Decision I

Chapter Eleven Asset Markets.

Agricultural Marketing

TRADING COURSE © Copyright Options Trading IQ. All Rights reserved.

Understanding interest rates

Futures Contracts Interest Rate Futures “Cheapest to Deliver” Bonds.

Presentation transcript:

Arbitrage in the US Treasury Market? "We firmly believe that the on-the-run issues should command a high liquidity premium in the current environment. But with very high probability, the 5 1/2s of 8/15/2028 will NOT be the current bond a month from now. The Bond/Old Bond spread is currently about 13bp. The average of this spread around auction is historically about 3bp. Hence we think that much of the premium now assigned to the current bond should be ultimately passed on to the new issue by the expected auction date. Therefore it makes sense to begin scaling into a reverse roll now, at these levels." Report from US Treasury bond trader to Fixed Income clients, Goldman Sachs, 6th October 1998.

GLOSSARY On-the-run: The most recently issued Treasury bond in any given sector (e.g. 10 year sector, 30 year sector) of the yield curve. The Current Bond: the most recently issued 30 year US Treasury bond (also shortened to just "The Bond"). The Old Bond: the second most recent 30 year US Treasury issue. Bond/Old Bond spread: the yield difference between the most recent and the previously issued 30year Treasuries. Basis point (bp): 1/100 * 1%

The Yield Curve NO NO YES! 2/28 5/28 8/28 All of these bonds are in the 30yr "sector" of the yield curve. 3bp Yield Bond Maturity 1yr 5yr 10yr 30yr Yield The yield on the "on-the-run" 30yr bond is lower than similar bonds => it is worth more: Liquidity? WHY? Different Maturity? Better Credit? NO NO YES!

Properties of the on-the-run Bond Tighter bid-offer spread Transactions costs are lower for quick and easy buying & selling Worth more (=> lower yield ) This Liquidity Premium has historically been worth about 3bp … So why is it worth 13bp today? Why is there an extra 10bp? Could it be Arbitrage? The Goldman Sachs US Treasury bond trader thinks so!

The Arbitrage Trade TODAY ONE MONTH's TIME 13bp 13bp Yield Yield 13bp 13bp 2/28 5/28 8/28 2/28 5/28 8/28 11/28 Sell the 8/28 (today's "on-the-run" bond) Buy back the 8/28 (today's "old" bond) Buy the 5/28 (today's "old bond") Sell the 5/28 (today's "old old bond") Net cost: zero (now the two bonds cost the same amount; liquidity premium is now on the new "on-the-run" bond) Net Profit: 13bp (because the on-the-run is 13bp more costly than the old bond).