Fixed Income Arbitrage
Alternative Investments: Hedge Funds and Private Equity
FixedIncome Arbitrage By The Suits
The fixedincome arbitrage strategy is based on the idea that an investor assumes opposing positions in the market to take advantage of small price discrepancies while limiting interest rate risk. These strategies provide relatively small returns and, in some cases, huge losses. During the 1998 crisis virtually every major investment banking firm reported losses directly related to their positions on fixedincome arbitrage. However, fixedincome arbitrage has since become one of the most rapidly growing sectors within the hedge fund industry growing by more than $9.0 billion during 2005 totaling in excess of $56.6 billion. The fixedincome arbitrage strategy is a broad set of marketneutral investment strategies intended to exploit valuation differences between various fixedincome securities or contracts. These are the most widely used fixedincome arbitrage strategies in the market: Swap spread arbitrage (SS), Yield curve arbitrage (YC), Mortgage arbitrage (MA),
Volatility arbitrage (VA), and Capital Structure arbitrage (CS). For purposes of this report we will focus on SS and YC arbitrage. The Yield Curve Arbitrage strategy includes taking advantage of small mispricings within the yield curve through the use of Intellectual Capital, gathered through sophisticated Factor Models. The Yield Curve is assembled with Market
Data regarding yields at different maturities. Investors use the Yield Curve to extract implied information concerning
Forward and Swap rates as well. Arbitrageurs, through the factor models, identify mispricings along the curve and exploit them in the following way: Once an actionable mispricing is identified, Arbitrageurs engage in swaps, either long or short, with the hopes to profit before the market converges or before the swap expires. For example, if the three year market yield is identified as being too high, a
FixedIncome Arbitrage By The Suits
The fixedincome arbitrage strategy is based on the idea that an investor assumes opposing positions in the market to take advantage of small price discrepancies while limiting interest rate risk. These strategies provide relatively small returns and, in some cases, huge losses. During the 1998 crisis virtually every major investment banking firm reported losses directly related to their positions on fixedincome arbitrage. However, fixedincome arbitrage has since become one of the most rapidly growing sectors within the hedge fund industry growing by more than $9.0 billion during 2005 totaling in excess of $56.6 billion. The fixedincome arbitrage strategy is a broad set of marketneutral investment strategies intended to exploit valuation differences between various fixedincome securities or contracts. These are the most widely used fixedincome arbitrage strategies in the market: Swap spread arbitrage (SS), Yield curve arbitrage (YC), Mortgage arbitrage (MA),
Volatility arbitrage (VA), and Capital Structure arbitrage (CS). For purposes of this report we will focus on SS and YC arbitrage. The Yield Curve Arbitrage strategy includes taking advantage of small mispricings within the yield curve through the use of Intellectual Capital, gathered through sophisticated Factor Models. The Yield Curve is assembled with Market
Data regarding yields at different maturities. Investors use the Yield Curve to extract implied information concerning
Forward and Swap rates as well. Arbitrageurs, through the factor models, identify mispricings along the curve and exploit them in the following way: Once an actionable mispricing is identified, Arbitrageurs engage in swaps, either long or short, with the hopes to profit before the market converges or before the swap expires. For example, if the three year market yield is identified as being too high, a