What are Fixed Income Arbitrage Strategies?
An investment strategy that attempts to make money from arbitrage 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. When using a fixed-income arbitrage strategy, the investor assumes opposing positions in the market to take advantage of small price discrepancies while limiting interest rate risk.
Why You Care
Fixed-income arbitrage is primarily used by hedge funds and leading investment banks, not individual investors. The most common fixed-income arbitrage strategy is swap-spread arbitrage. This consists of taking opposing long and short positions in a swap and a Treasury bond. Such strategies provide relatively small returns and, in some cases, huge losses. That's why these strategies are often referred to as "picking up nickels in front of a steamroller"!
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.