Bond Carry and Roll Trades Using Repo Financing and Short Bonds
Summary
The document outlines a bond carry and roll trade in which repo financing supports a long position in a longer-maturity bond while a short position in a shorter-maturity, negatively yielding bond can complete the relative trade. It explains that the short bond is borrowed through repo, sold, and the proceeds are lent back, with the financing legs intended to offset so the exposure is principally long the longer bond and short the shorter one. The short and long positions may benefit from their respective movement along the yield curve toward maturity.
A separate illustration compares a bond yield with a more negative repo financing rate to show positive carry. The discussion stresses that carry does not guarantee profit: interest-rate moves can cause larger mark-to-market losses, balance-sheet and capital costs matter, and roll-down or bond price changes can offset expected income. The examples are simplified and provide no complete transaction accounting or empirical performance evidence.
Key ideas
- A repo-financed long bond position can earn carry when financing terms are more favorable than the bond yield.
- A relative carry and roll trade can pair a long longer-maturity bond with a short shorter-maturity bond.
- The short bond leg involves borrowing the bond, selling it, and lending the cash proceeds back.
- Repo legs may offset in a simplified explanation, but full trade economics depend on actual financing and balance-sheet terms.
- Interest-rate risk, capital costs, and price changes from rolling toward maturity can outweigh carry.
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Full text
# Carry & roll - question regarding the repo transaction # Carry & roll - question regarding the repo transaction Could someone please explain the carry and roll trade that a lot of traders are doing with negative euro debt? I read an example that they borrow in the repo market then buy a longer dated bond to generate positive carry - but can someone please explain the repo part? They would have to own a short dated bond to be able to repo it to get financing to purchase the long dated bond right? If so, shouldn't the cost of purchasing the short dated bond be factored into the profit calculations? ## Answer by VanillaCall (score 1) https://quant.stackexchange.com/a/47243 The transaction is basically just going into repo, borrowing cash and buying a long dated bond. Then using that bond and giving it to the repo desk as collateral. The repo is negative so you're being paid. Secondly, you short a negative yielding short maturity bond by borrowing the bond from repo desk, selling it in the market for cash and lending that cash to the repo desk. In this transaction, you're selling a negative yielding bond at a price higher than par (at premium). Then you lend out cash, presumably at a negative rate meaning you will probably pay repo. The repo legs should cancel out so you're left with the long on the long dated bond and the short on the short dated bond. The short leg rolls up the curve due to pull to par since it's negative yielding and your long leg should roll down. ## Answer by Attack68 (score 1) https://quant.stackexchange.com/a/47249 If you buy a 30Y bond at (say) -0.1% via a repurchase agreement that pays (say) -1.0% then you will earn 0.9% per annum on a "carry" basis. However, this might not be attractive for one of these reasons (amongst others): - You are implictly assuming a large amount of market risk. If interest rates fall you might lose substantially more on the capital than your "carry" brings in. - You do not have the balance sheet capacity to support the trade, i.e. the Basel capital requirements for holding such a liability and asset considerably mitigates the potential gain of 0.9%. - You have not accounted for any roll-down or adjusted bond price that mitigates any of this gain upon your eventual sale of the bond 1Y later. On the flip side, if your view is that bond yields will fall this trade allows you to express that view with an element of carry embedded and potentially limited amounts of capital for investors, and so might have been quite popular amongst eur investors in the last few months, and particularly profitable.
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.