Trading in Rates
I am currently reading “Interest Rate Swaps and Their Derivatives: A Practitioner’s Guide” and am having trouble understanding how money is being made in one of his examples. I have read and re-read it like 30 times and am about ready to poke myself in the eyes.
Using the following swap:
2y 4% 30-Sep-09 Price: 100-09/100-092 Treasury Yield: 3.84235% - 3.84657% Swap Spread: 55/55.5 Swap Rate: 4.39235/4.40157
This is the scenario using the above swap:
If I am looking to receive 100m 2y swap. Rates.
Dealer has spreads at 55-55.5 with the 2y trading at 100-09/10-092 (3.84235%-3.84657%), and will pay 4.39235% (=3.84235% + 55bp).
Author says as soon as I accept this trade, I will cover my short and buy treasuries, lifting the offer of 100-092. Leaving me with spread risk, where I am paying the bid side (55 bp) of the swap-spread market. With enough 2-way flows, I will try to pay the bid side of the swap-spread market, and receive the offered side, and make a living out of the bid-offer spread (of the swap market).
Here is my guess:
We are receiving Fixed at a spread of 55 and we are paying the floating spread starting at a spread of 55. However, to hedge this risk we have bought (assuming this is the meaning behind “lifting the offer”), at 100-092, which is higher than the 100-09 we are paying. This difference is the profit that we are pocketing. 100-092 – 100-09 is my profit.
Also, am I correct in assuming that the reason 2 prices, spreads, rates, etc. are quote because the first is the bid and the other is the offer?
Thanks