alternative investment: fixed income arbitrage fund long, why, investment, position, income

spartanag07

fixed income arbitrage: short treasury and long high credit risk bond: why in a downturn market, the loss in the short position in treasury typically outweights the long position?
I thought in a market downturn, short position should at least have some gain….

dvilayphet

It’s not really about short have some gain, it’s about the spread….during a boom, interest rate spread tightens:
- Interest rates on high credit risk bonds fall (hence prices of bonds go up) so they make money
- Interest rate on treasuries go up, and hence prices drops, and they make money.
In a downturn, the opposite will happen (everyone buys treasuries and flee the risk, raising the interest on high credit risk bonds… and the spread widens…

dvilayphet

The are the SHORT the bond PRICE. Economy drops off, people allocate away from equities into bonds, yields go down but the Bond price value does UP - they lose on the trade as prices are rising and they are SHORT.

BC_MBA_student

The question is trying to say (I think) that in a downturn market, the loss in the short position in treasury typically outweighs the “loss” in the long position. It seems they are saying that in a downmarket you lose on both positions (short treasuries, treasury prices go up, you lose…long bonds, bonds sell off, bond prices go down, you also lose). If I’m following this correctly, the loss from the treasuries is larger, may be because they go up much higher in percentage terms than corporate bonds go down!