[1] Fixed-income securities are debt instruments issued by a government, corporation, or other entity to finance and expand their operations.
[3] The mechanics of the agreement are similar across all variations of fixed-income instruments, whereby there is a fixed tenor and schedule of income payments.
[7] The group paying the fixed-rate, which is the owner of the Treasury bond financed at the repurchased rate, will also receive a fixed-coupon on the yield to maturity (E.g. yield to maturity of the treasury bond), whilst paying interest on the repurchase agreement, known as repo financing.
This is because the BBSW is used as a benchmark for the pricing of AUD derivatives and securities, hence the repurchase rate of the Treasury Bond should be higher.
[7] Once this has been identified the investor will seek to profit off either the rich or cheap points on the yield curve by going short or long bonds.
In taking short and long term positions on the yield curve, the investor is hedging their investments.
The reason that MBS's tend to have a higher yield is because of the general risk that the assets that they are secured by pose.
[17] Similar to the case of finding the real price of a stock, in this strategy the arbitrageur must make a judgement on whether implied volatility of a security is overpriced or under-priced.
An example of this would be in the opportunity in which a stock option is considerably under-priced because the implied volatility of the asset was too low, in a move to profit off the mispricing the arbitrageur would subsequently choose to open a long call option combined with a short position in the underlying stock.
[13] Capital structure arbitrage is a strategy used globally in finance, designed to profit from current market mispricings in security classes issued from a single company.
The structure model is designed to calculate the fair value of such CDS spreads based on a company's debt and other securities.
The strategy itself provides relatively small returns that can be offset with huge losses given varying market conditions and poor judgement calls.
It is more often used by asset rich groups, such as hedge funds and investments banks that have significant capital that can be deployed to capitalise on the smaller-riskier returns.