Posted in Finance, Accounting and Economics Terms, Total Reads: 390
Definition: Fixed Income Arbitrage
It is an investment strategy which exploits the differences of prices of fixed income securities. Arbitrage involves buying fixed income bonds in one market and selling it in another. The price differential should be such that the trader is able to exploit the discrepancy after the transaction costs are taken into account. The arbitrageurs help in finding the right price for the security by repeated selling and buying and after sometime time the price discrepancy disappears.
Credit default swaps are often used in fixed income arbitrage. The strategy called ‘swap-spread arbitrage’ involves taking a bet on which direction the CDS will move. Another strategy is capital structure arbitrage which involves exploiting the pricing differential on the pricing between the debt and stock of a company.
Arbitrageurs dealing with fixed income should be willing to take huge risks as return are small and potential losses are huge. It is mainly used by institutional investors who have well diversified assets and are willing to hold risky positions.