Fixed Income Arbitrage in a Financial Crisis (C) : TED Spread and Swap Spread in November 2008

Investment manager Albert Mills confronts an apparent arbitrage opportunity during the global financial crisis of 2008 when he notices an unusually low -- and briefly negative -- thirty-year U.S. dollar fixed-floating swap spread. Mills must decide if there is an opportunity, how to structure a trade to exploit it, and how much of his fund's capital to allocate. Case exposition includes descriptions of fixed-floating swaps, important interest rates and spreads (LIBOR, TED spread, swap spread), and financing arrangements, particularly repurchase agreements, that support relative-value strategies. Attention also is paid to bond math calculations that support the protagonist's analysis and decision. All quoted prices in the case are real and historical, and corresponding Bloomberg commands are provided for each as footnotes.Learning Objective:This case may be used: to introduce fixed-floating interest rate swaps; to review or introduce important interest rates and spreads, such as LIBOR, TED spread, and swap spread; to review or introduce valuation of fixed-income securities and derivatives and associated measures of price-sensitivities to interest rates; to review the Law of One Price (LOOP) and resulting opportunities when LOOP fails; to describe the mechanics of exploiting violations of LOOP; and to describe hedge fund financing arrangements, particularly repurchase (repo) agreements. The case also may be used: to discuss the causes of anomalous securities prices during the 2008 crisis; to explore causes and consequences of the 2008 crisis generally; and to discuss possible interventions by government, central banks, and other oversight bodies