Buying bonds and paying fixed in a swap nets a small positive cash flow.
Evidence
A tiny positive cash flow could thus be obtained by buying bonds yielding 6.77 percent, funding the purchase at repo rate, and paying fixed interest in a swap while receiving Libor in return. The incoming cash flow would be in effect 6.77 percent + Libor, while the outgoing flow would be repo rate + 6.94 percent. Since Libor was 20 basis points above repo rate, the net annual cash flow was thus three basis points. — Donald MacKenzie, An Engine, Not a Camera, 1299
Categorization
- DEFINE: Concretely demonstrates the mechanics of the bond-plus-swap arbitrage trade in arithmetic terms.
- XREF: connects to: Swap spreads reveal arbitrage opportunity between swaps and equivalent bond positions — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 980; Swap spreads mean-revert, letting traders bet on widening to profit. — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 1301; Swap credit risk covers only net interest differences because principal is notional — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 984
Broader Connections
- Swap spreads reveal arbitrage opportunity between swaps and equivalent bond positions
#expands(0.85) — Donald MacKenzie, An Engine, Not a Camera, 980 - Swap credit risk covers only net interest differences because principal is notional
#expands(0.80) — Donald MacKenzie, An Engine, Not a Camera, 984 - Swap spreads mean-revert, letting traders bet on widening to profit.
#expands(0.75) — Donald MacKenzie, An Engine, Not a Camera, 1301