Carry on a Long Bond and Short Euribor Futures Hedge
Summary
The document analyzes the carry of a long bond, short futures position used to hedge interest rate exposure. It frames carry as coupon income minus financing cost. When the bond yield is below the short-term rate used to fund it, the financing expense exceeds the income, producing negative carry while the basis is unchanged. The example compares a one-year par bond funded at a higher three-month Euribor rate over a three-month period and calculates the resulting loss.
The discussion distinguishes carry from changes in the hedge basis: the stated loss applies if the basis does not move. It does not quantify futures price effects, bond price changes, roll, transaction costs, or the detailed mismatch between the bond and futures hedge. The result therefore describes the simplified financing intuition for the specified setup, rather than a complete profit-and-loss forecast.
Key ideas
- The position is described as long a bond and short interest rate futures.
- The stated carry measure is coupon income minus financing cost.
- Funding a bond below its yield creates negative carry when the short rate is higher.
- The example's loss assumes the basis remains unchanged.
Tags
Full text
# Long Bond & Interest Rate Futures Hedge - is it carry negative? # Long Bond & Interest Rate Futures Hedge - is it carry negative? The situation is the following : - A bank treasury book, finances its cash bond liquidity portfolio at Euribor 3m flat. - The Euribor curve is deeply inverted. - The bank invests in bonds with a positive spread over the swap curve, but the bonds' yield is below the 3M Euribor it pays to purchase them (curve is inverted). - To hedge IR risk and lock in a spread over swaps, bank sells Euribor futures strips to hedge bond purchases. Assuming no change in rates over a time period T, is the overall carry on this position positive or negative ? What are the factors that determine it ? ## Answer by AlRacoon (score 2) https://quant.stackexchange.com/a/78450 The position you describe is a long basis position--Long Bond, Short Future. Carry is the difference between Coupon and Financing. $$Carry = Coupon - Financing$$ As you mentioned, the yield is less then 3M Euribor that is being used to finance the position implies that you are earning less in interest than the cost to finance the position, therefore the Carry is Negative. Let's take an example: Say 3M Euribor is 6% and 1Yr Euribor is 4%. If you are financing a 1Yr 4% annual coupon, yielding 4%, Par bond for 3 Months, the interest (Coupon) earned would be 1% in 3 Months. Since you are funding the position with 3M Euribor for 3 Months, the financing would be 6% x 90/360 = 1.5%. $$Carry = (0.01)(100) - (0.015)(100) = (-0.005)(100) = -0.5$$ This represents a loss for a long basis position, if basis stays the same.
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