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Fixed Income Arbitrage

Fixed income arbitrage is a trading strategy that seeks to exploit price differences between related fixed-income securities, such as bonds or interest rate derivatives. Traders use various arbitrage techniques, including spread trading, swap arbitrage, and yield curve arbitrage, to profit from small pricing inefficiencies. Fixed income arbitrage typically involves taking long and short positions to hedge risks while capturing gains from mispriced securities. This strategy is widely used by hedge funds and sophisticated investors.

Example

A hedge fund engages in fixed income arbitrage by buying an undervalued corporate bond while shorting an overvalued bond of similar risk, aiming to profit from the price convergence.

Key points

• Exploits price discrepancies between related fixed-income securities.

• Involves hedging through long and short positions.

• Commonly used by hedge funds to achieve low-risk profits.

Quick Answers to Curious Questions

Profits are made by exploiting mispricing between similar securities, with gains realized when prices converge to their correct values.

Risks include model risk, market volatility, and liquidity risk, which can lead to unexpected losses if price discrepancies persist or widen.

It offers opportunities for relatively low-risk returns by taking advantage of small market inefficiencies, fitting well within complex investment strategies.