APPROACHES TO GOVERNMENT BOND TRADING AND YIELD ANALYSIS47
In this chapter we consider some approaches to government bond trading from first principles, based on the author’s experience in the UK gilt market. It is based on a series of internal papers written by the author during 1995-1997, and while the observations date from some time ago the techniques described can be applied to any government market and are still in widespread use. We also incorporate for this edition a look at some useful Bloomberg screens that can be used as part of the analysis.
We also look at measuring relative value, from the perspective of the fund manager.
Portfolio managers who do not wish to put on a naked directional position, but rather believe that the yield curve will change shape and flatten or widen between two selected points, put on relative value trades to reflect their view. Such trades involve simultaneous positions in bonds of different maturity. Other relative value trades may position high-coupon bonds against low-coupon bonds of the same maturity, as a tax-related transaction. These trades are concerned with the change in yield spread between two or more bonds rather than a change in absolute interest-rate level. The key factor is that changes in spread are not conditional upon directional change in interest-rate levels; that is, yield spreads may narrow or widen whether interest rates themselves are rising or falling.
Typically, spread trades will ...