An Examination of the Time Value of Money on Bond Curve Trading Strategies

Voiceover

Presenter(s)

Pranay Gundam, Katherine Shaw, Eleanor Xiao, Victoria Han

Abstract or Description

A concept in finance that is often misunderstood is the number of factors that influence the profitability of curve trading. One such factor is positive carry, which refers to a scenario when a trade profits off of the difference between interest earned and interest owed, not considering the cost of financing. In fact, some analysts claim that positive carry trades will always produce a profit, even when changes in the yield curve are disregarded. However, it is possible that such a trade may lose money due to pull-to-par. Pull-to-par is the tendency of a bond’s flat price to gravitate toward its par value as it approaches its maturity date. Our group works to investigate this idea by comparing how profiting off of steepening in the yield curve differs from profiting off of positive carry. We analyze this trade on three fronts — precise mathematical values, historical data, and continuous time simulations — to account for factors like pull-to-par. In our research, we find that for traditionally assumed, safe-for-profit positive-carry trades, the losses from the trades' pull-to-par effect may dampen the profit gained from the positive carry, indicating the importance of looking beyond merely the trades' carry. 

Mentor

Professor William Hrusa