Butterfly in Fixed Income Trading Strategies. Through the secondary market, you can also buy and sell bonds in ways that support many different investing strategies. Buying a basket of bonds with a method called a butterfly, allows you to speculate on certain changes in the relationship between the returns of short-term and long-term bonds. PIMCO strategies utilize derivatives which may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could Author: PIMCO. the trading discipline outlined above coupled with the use of the highly liquid TBA market, we maximize the opportunity to capture hidden value in the mortgage sector. For example, let’s consider a basis trade where mortgages are trading cheap.
Figure 1 below shows the average daily trading volumes of agency mortgage-related securities since Notably, the TBA data shows up as a category only sinceTba trading strategies, when it became tracked by TRACE; however, based on anecdotal evidence, we would expect the — period to show a similar share of TBAs out of the total agency mortgage-related trading as displayed in and In addition, we discuss the investment rationale and risks of the TBA market for insurers, and lastly, touch upon the potential impact on the TBA market from the impending U.
Furthermore, only conforming mortgages — which meet a certain size Tba trading strategies credit quality criteria — can be guaranteed by the agencies. These very specific requirements result in the standardization, and, therefore, the liquidity, of the TBA market. In a TBA trade, two parties — usually an investor or market maker and a loan originator — agree on a price for delivering a certain amount of agency RMBS at a specific future date.
A distinguishing characteristic of a TBA trade is that, at the start of the transaction, the actual identity of the Tba trading strategies securities to be delivered at settlement is not stipulated. Instead, the two parties agree on six parameters of the TBA trade: issuer, coupon, maturity, price, face value or par amount and the settlement date.
A timeline for a typical TBA trade is depicted in Figure 2 below. Therefore, depending on when the next monthly settlement is, the trade date will usually precede the settlement date by two to 60 days. The homogeneity assumption is a cornerstone of TBA trading, helping to transform an essentially heterogeneous set of individual underlying mortgages into a large set of fungible i. This liquidity and ease of mortgage risk management by transferring said risk from one market player to another is what makes the TBA market so important and prevalent in the overall MBS market, ultimately resulting in lower mortgage rates.
To that Tba trading strategies, because mortgages in Tba trading strategies TBA trade do not have to be identified until the notification date, they might not even exist at the trade date. Therefore, the TBA market is critical for lenders, as it enables them to hedge their own interest rate risk when they offer potential mortgage applicants an option to lock in a mortgage rate for anywhere between 30 and 90 days.
Although lenders can use other instruments to hedge this particular interest rate risk exposure, the TBA market offers the most efficient hedge for their mortgage-origination efforts. Short-term Investment. A discussion of the TBA market would not be complete without a mention of specified pool trading and dollar rolls. Specified pool trading refers to agency RMBS trading outside Tba trading strategies TBA market, where investors specify securities to be delivered into Tba trading strategies pool, making it a substantially less liquid market.
By selling the front month TBA, Tba trading strategies, the investor foregoes the delivery of the securities and operational issues that come with it, foregoes any coupons and prepayments that the TBA would generate in the interim, but has funds that can be reinvested in the short-term based on the London Interbank Offered Rate LIBOR.
This short-term interest and the price drop of the back month TBA repurchase are the sources of income generation in the dollar roll trading for investors, and many investors actively roll from one month into another, enjoying the benefit of the TBA market liquidity and exposure to MBS without the adverse consequences of receiving delivery of a Tba trading strategies mortgage pool, Tba trading strategies.
Additionally, some insurers may use TBA securities to hedge interest rate risk exposure arising from other rate-sensitive securities they may be holding. The risks of TBA investing are similar to those resulting from other mortgage-related investments, including interest rate and prepayment risks.
SSAP No. In addition, TBAs generally do not have varying structures. Moreover, other parts of Schedule D Part 3 through Part 5 do not even provide a Code field, leaving the Description field as the only place to note a particular holding or transaction as a TBA.
Lastly, we noted in our analysis that there were wide variances in how the Description field was filled out for TBAs. Given this variability of terminology or lack of proper identification altogether, we believe that our totals in the analysis above are Tba trading strategies than the actual amounts, albeit most likely not by a significant measure.
Although, technically, Tba trading strategies, TBAs are not derivatives despite their forward commitment, some insurers may have classified them as such because these securities may have been used for hedging certain interest rate exposures. Therefore, we reviewed the intra-year trading activity as captured by Schedule D, Part 5, Long-Term Bonds and Stocks, and Schedule DB, Part A, Section 2, Derivatives in the latter, we deducted the prior year-end holdings to avoid double-countingwhich revealed much broader insurer participation.
In terms of specific Tba trading strategies groupslife companies have been responsible for about Fraternal insurance companies were a distant second in TBA trading activity, contributing Therefore, the fraternal industry exhibited the highest insurer concentration, even after taking other factors into account, with most transactions indicative of TBA usage for dollar rolls and a likely investment strategy of income generation. We selected only one out of the four schedules reviewed in the analysis above in the interest of minimizing time and complexity, while still capturing a historical trend.
Although that year peak activity was almost five times larger than in the past couple of years, it appears less striking when we overlay our insurer TBA activity data with the agency MBS issuance numbers Figure 3.
In this context, the peak TBA activity by insurers in is, therefore, much less surprising than the fact that TBA activity has not been higher in recent years, Tba trading strategies, especially in when the second-highest amount of MBS was issued between and The most obvious explanation for the decline in TBA activity is that, subsequent to the financial crisis, the majority of companies with sizable investments in mortgage-related securities have scaled back their exposure to them, having suffered serious losses during the crisis and having found a new sense of risk aversion or at least caution toward mortgage-related products.
Although mortgages underlying TBAs carry an explicit or implicit government agency guarantee, Tba trading strategies, the perceived risk of any mortgage-related asset Tba trading strategies investors has been noticeably higher since Lastly, another potential factor contributing to the lower TBA activity reported on Schedule D Long-term Bonds and its various parts could be a shift by some insurers toward reporting such activity on Schedule DB Derivatives instead, as that schedule has become more detailed and transparent in the recent years.
However, we have not performed extensive analysis of that conjecture at this time. Therefore, were we to aggregate the Schedule D Tba trading strategies DB numbers for the past 10 years, they would still show a downward trend in insurer TBA activity, although likely with a less steep slope.
The Agencies have historically played a vital role in the U. The Agencies serve as a cornerstone for the proper functioning of the TBA Tba trading strategies and its resultant size and liquidity. However, the Agencies, Tba trading strategies, particularly Fannie Mae and Freddie Mac, are currently under intense scrutiny and reexamination, following their near default after the financial crisis and subsequent governmental conservatorship.
The U. Treasury Department and Congress are in the process of considering and evaluating different options for reforming the GSEs, ranging from full privatization to full nationalization, with several other options in between. The potential removal of the Agency guarantee, or, even worse, of their overall gargantuan participation, would likely have a significantly detrimental Tba trading strategies on the TBA market and its liquidity, ultimately trickling down to individual borrowers in the form of higher mortgage rates.
Both SIFMA and the Federal Reserve Bank of New York have expressed their foremost concern over the viability of the TBA market as a result of the housing finance reform, and they have argued that whatever solution is eventually arrived at, Tba trading strategies, it should include the TBA market in some shape or form.
The Capital Markets Bureau will continue to monitor trends surrounding the TBA market and the impact on insurance industry investments. We will report on any developments as deemed appropriate, Tba trading strategies.
Questions and comments are always welcome. The views expressed in this publication do not necessarily represent the views of NAIC, its officers or members. Short-term Investment A discussion of the TBA market would not be complete without a mention of specified pool trading and dollar rolls, Tba trading strategies. All rights reserved.
Trading desks may trade or may have traded as principal on the basis of the research strategist(s) views and report(s). Therefore, this research may not be independent from the proprietary interests of JPMSI trading desks which may conflict with your interests. PIMCO strategies utilize derivatives which may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could Author: PIMCO. Butterfly in Fixed Income Trading Strategies. Through the secondary market, you can also buy and sell bonds in ways that support many different investing strategies. Buying a basket of bonds with a method called a butterfly, allows you to speculate on certain changes in the relationship between the returns of short-term and long-term bonds.