Bond Trading Primer: Positive Carry
May 30, 2008
John Jansen submits:
Several readers have requested a discussion of positive carry and the ride down the yield curve. I will assume a par bond of $1mm and no accrued interest.
I will use the approximately the same set of facts I used in my closing commentary yesterday. That is, the current 2 year note with a 2 5/8 coupon.
I will use a term repo rate to September 30th of 1.60 percent.
The repo begins on June 2 and matures on September 30. That looks to be 121 days.
So the repo calculation is( $1mm X .016 ) divided by 360 days times 121 days. That works out to $5377 and means that if you own the bond and financed the bond for the 121 day period at 1.60 percent you had a cost of $5377.
However, as the owner of the bond you are accruing that 2.625 percent coupon over that same period. So you earned ($1,000,000 X..02625) divided by 365 times 121 day. That works out to $8702 accrued interest for the 121 days.
$8702 minus $5377 equals $3325 of POSITIVE CARRY for each $1 million bonds.
For purposes of this discussion and simplicity I am going to arbitrarily reduce the $3325 to $3125. That is because bonds trade in increments of $312.50 per million bonds. So my arbitrary $3125 is equal to 10/32 on the $1mm par bonds.
That 1/32 increment has a value in basis points of yield. The yield value of that 1/32 increment is 1.7 basis points. So in my example the 10/32 is equal to 17 basis points. So, ceteris paribus, if I buy the bond today at a yield of 2.625 percent (par) and finance it under the set of circumstances presented here, I have a cushion of 17 basis points. So if the yield on the bond on Sept 30 is approximately 2.79 percent I have a break even transaction. There is one more step to complete the analysis.
There is one other consideration and that is the steepness of the yield curve.
Over the term of this transaction the note that we own will slide down the curve and finish as a 20 month note rather than the 24 month note at which it began. We assume that the shape of the yield curve will be the same at the end of the 120 day repo as it is at the start. At the close of business yesterday that 4 months was worth about 12 basis points. So all other things being equal the 2.625 yield today will be approximately a 2.50 percent yield on September 30.
I add those 12 basis points of yield to the 17 basis points which I earned in the financing leg of the transaction and my breakeven is now 29 basis points.
So under that set of assumptions I can buy the 2 year note today at 2.625 percent and breakeven on September 30th if the yield on the 2 year note is less than 2.915 percent. (2.625 plus the 29 basis point cushion).
If you believe that the FOMC is about to embark on a policy of serial tightenings, that is a very bad trade. If you think that the Federal Reserve is on hold and that the funds rate will be 2 percent for the rest of our natural lives it is a fair bet. And if you believe that we are in the midst of a protracted slowdown and that the FOMC will be forced to cut rates again sooner rather than later then it is a great bet.
Bond Trading Primer: Positive Carry
Waiting for the Rise of the Phoenix
May 30, 2008
Cam Hui submits:
As a follow up to my previous post on Altman Z score, investors who use solvency analysis to avoid bankrupt companies should beware of the effects of an economic recovery. The other side of the coin of solvency analysis is the Phoenix effect.
When the economy comes out of recession, shares of near-bankrupt companies see eye-popping returns as they rise Phoenix-like from the ashes of near insolvency. Examples include Chrysler moving from $2 to over $30 in the 1982-3 recovery; Magna International (MGA) from under $2 to over $80 in 1991-2; and Akamai Technologies (AKAM) from under $2 to over $18 in 2003-4.
Waiting for the Rise of the Phoenix
London’s Commercial Property Market Up, NYC Down [Housing Tracker]
May 30, 2008
London’s Commercial Property Market Up, NYC Down [Housing Tracker]
Bond ETFs: Are Treasury Bonds Entering a Downtrend?
May 30, 2008
Gary Gordon submits:
In the summer of 2007, the Fed found itself abruptly veering from its rate-raising course to slashing the rates borrowed by banks at the discount window. The help was temporary, as the word "subprime" and the phrase "credit crunch" dominated the headlines.
For 9 months, treasury bonds became the ultimate safe haven for fearful investors. Until March.
Bond ETFs: Are Treasury Bonds Entering a Downtrend?
Real GDP and Inflation
May 30, 2008
Curious about what "inflation adjusted" economic growth might look like with different levels of inflation, whipping up one more animated .gif seemed an appropriate thing to do. The second frame - Inflation as Stated - is what the official Commerce Department data indicated this morning. May 30, 2008 On Tuesday, we noted that New Home Sales fell 42%. 1) Revisions: April’s (unrevised) data for new homes was 526k May 30, 2008 In trying to understand how we continue to get such freakishly low readings in the price indexes that come out with the reports on economic growth, this data was stumbled upon: How Is the GDP Price Index Down This Much? May 30, 2008 The Department of Commerce released the "preliminary" estimate for first quarter GDP indicating an improvement to a seasonally adjusted annualized growth rate of 0.9 percent. The 0.3 percentage point gain from last month’s "advance" reading of 0.6 percent was driven by a gain of 0.6 percentage points due to a lower trade deficit combined with a 0.3 percentage point decline in private domestic investment largely due to a change in inventories as shown below. The GDP price deflator, used to adjust "nominal" GDP to "real" GDP was unchanged from the advance estimate at 2.6 percent. With soaring prices for both food and energy during the first quarter of the year, does anyone really believe that a 2.6 percent annualized rate of inflation is the right number to be used to calculate "inflation adjusted" growth? U.S. Q1 GDP Improved: Don’t Get Too Excited May 30, 2008 Jason Schwarz submits:
The Financials U.S. Market Setting Up for a 2nd Half Rally May 30, 2008 Michael Shedlock submits:
HousingWire is reporting S&P Lowers the Boom on 1,326 Alt-A RMBS Classes.
Tim Iacono submits:
Not So Fast On New Home Sales
Barry Ritholtz submits:
There was one small piece of the data I failed to mention earlier in
the week, which is worth discussing — the March revisions:
annualized units (+3.3). That is the identical to the number released
in March — 526k units. March sales were revised to -11%
from -8.5%. So but for the revisions, March to April headlinenumber was flat. 
How Is the GDP Price Index Down This Much?
Tim Iacono submits:
Can anyone explain to me how rising import prices cause the GDP price index to go down this much? I understand the basic principle of how imports/exports are accounted for in the GDP number, but these percent contributions look exceedingly large.
U.S. Q1 GDP Improved: Don’t Get Too Excited
Tim Iacono submits:
Don’t get too excited.
Yesterday’s report is the second of three reports for economic growth during the first quarter - the "final" estimate will be released at the end of June.
U.S. Market Setting Up for a 2nd Half Rally
turmoil caused by the credit crisis of Q1 caused many investors to
leave the game and sit on the sidelines. The volatility was too much
to handle. The question now is, when to re-enter the market? The
S&P 500 is down 5% for the year but recent statements by
influential market players suggest that now is the time to load up for
a 2nd half rally. Three of the major areas of concern,
financials (XLF), oil (USO), and the US dollar (UUP) appear to be setting us
up for a run:
Bring on the Alt-A Downgrades
-
Recent Posts
- Renewed Infrastructure Growth in Environmentalists’ Best Interest
- Geithner, Summers Represent Change at Treasury
- Existing Home Sales Clunk Along Bottom
- Shelf Filings Are Increasing, But Don’t Get Excited
- More on Hindsight Bias
- Obama’s Real Economic Team
- Forex Interplay: Euro vs. Dollar As Risk Appetite Returns
- U.S. Public Pension Plans Able to Recover from Market Slump
- Profiting From Risk Aversion
- Wall Street Journal: Homebuilders Want $250 Billion Stimulus
-
Latest S.E.C. Filings- 6-K - JA Solar Holdings Co., Ltd. (0001385598) (Filer)
- 6-K - NOVO NORDISK A S (0000353278) (Filer)
- 8-K - USA TECHNOLOGIES INC (0000896429) (Filer)
- 8-K - DIONEX CORP /DE (0000708850) (Filer)
- 8-K - THEATER XTREME ENTERTAINMENT GROUP, INC (0001089775) (Filer)
- 8-K - GMAC LLC (0000040729) (Filer)
- 8-K - DTE ENERGY CO (0000936340) (Filer)
- 8-K - DETROIT EDISON CO (0000028385) (Filer)
- 10-Q/A - CHINA SECURITY & SURVEILLANCE TECHNOLOGY, INC. (0001260625) (Filer)
- 10-Q/A - CHINA SECURITY & SURVEILLANCE TECHNOLOGY, INC. (0001260625) (Filer)