RV trade on TIPS

longvega · March 9th, 2009, 2:14 pm

It is well know that TIPS are trading cheap vs nominals on an asset swap basis. Ideally one needs to go long TIPS and short nominals without taking any credit risk (expect for swap c/p risk)....is there a smart way for an investor (who cannot enter into swaps) to express this view (using an SPV perhaps?)Any ideas?

Traden4Alpha · March 9th, 2009, 2:41 pm

You might look into a couple of ETFs that replicate a short position in medium and long-term TBills (PST and TBT). But read http://www.wilmott.com/messageview.cfm? ... adid=68642 before assuming that these exactly replicate the inverse of the TBills.

Martinghoul · March 9th, 2009, 3:45 pm

Firstly, TIPS are cheap on asset swap for a very good reason that's not about to go away. Essentially, if I understand you correctly, you want to buy TIPS breakeven vs selling CPI swap breakeven to obtain exposure to the asset swap differential between TIPS and nominal treasuries. If that's the case you need some sort of access to inflation as implied by swaps. I do not know of any instruments (other than inflation swaps) that can give you this exposure.

daveangel · March 9th, 2009, 3:52 pm

I think he just wants to be long b/even inflation from TIPS

Martinghoul · March 9th, 2009, 4:08 pm

QuoteOriginally posted by: daveangelI think he just wants to be long b/even inflation from TIPSThat's easy enough, but why all the talk of asset swap then?

daveangel · March 9th, 2009, 6:36 pm

i think he wants to buy TIPS and short nominals against.

longvega · March 10th, 2009, 8:49 am

I am thinking of a trade, where I dont have any exposure to inflation/breakeven but to benefit from the asset swap differential between TIPS and nominals. This seems like a 'risk free' trade on a hold to maturity basis...but my question is a) how do you setup the trade using repos b) is it easy enough to do this to maturity and c) what are the risks?Thanks!

Martinghoul · March 10th, 2009, 9:52 am

QuoteOriginally posted by: longvegaI am thinking of a trade, where I dont have any exposure to inflation/breakeven but to benefit from the asset swap differential between TIPS and nominals. This seems like a 'risk free' trade on a hold to maturity basis...but my question is a) how do you setup the trade using repos b) is it easy enough to do this to maturity and c) what are the risks?Thanks!What you're looking for is to go long breakeven inflation expressed through TIPS vs shorting breakeven inflation by recv fixed on a CPI zero-coupon inflation swap. Barring the convexity issue (one's a zero-coupon, the other isn't), this trade expresses the asset swap differential. Now, as to your questions: a) I have no idea what you mean about repos; b) no, it's not easy, because you won't be able to lock in the funding to maturity on the bond side, even for the shortest TIPS; c) risks are that we have another repo/money mkt blowup similar to what happened in December, where you can't fund your bonds (see what happened to the spread on the chart).

longvega · March 10th, 2009, 10:10 am

Martinghoul,Your suggestion still leaves me with credit risk (on US Tsy) since I am long TIPS...I wish to enter into a trade where I dont have any credit risk on US. I thought it should be possible in theory by going long TIPS on asset swap basis and shorting nominals on asset swap basis...it might not be possible in practice because as you mention it might not be possible to short nominals on asset swap basis for long maturities

Martinghoul · March 10th, 2009, 10:25 am

QuoteOriginally posted by: longvegaMartinghoul,Your suggestion still leaves me with credit risk (on US Tsy) since I am long TIPS...I wish to enter into a trade where I dont have any credit risk on US. I thought it should be possible in theory by going long TIPS on asset swap basis and shorting nominals on asset swap basis...it might not be possible in practice because as you mention it might not be possible to short nominals on asset swap basis for long maturitiesBeing long TIPS on asset swap means you're taking the inflation-linked cashflows from the US Trsy and passing them on to your asset swap counterparty, in exchange for LIBOR flows. You're doing the opposite with being short nominal ASW. No matter how you slice it, due to the back-ended structure of TIPS cashflows, you will have exposure to US credit.