A Primer on Interest Rate Markets and Relative Value – Part 1: Yield Curve Opportunities and Risks
Government bond and interest rate derivative markets are among the largest and most liquid financial markets in the world. Interest rate markets are vital to the functioning of the financial system and present a wide range of long term investment and short term trading opportunities. The unique opportunities and risks within the interest rate market are not always obvious to multi-asset investors, especially where fixed income is a smaller allocation within their portfolios.
Relative value investing in interest rate markets provides a rich source of alpha potential for investors with low correlation to macroeconomic forces and directional moves in broader bond and risk asset markets.
This first paper in a series of primers on interest rate markets and relative value outlines common types of trades implemented and risks faced by market participants. Our emphasis is on the practical concepts and common issues faced by investors, rather than a detailed technical discussion on the mechanics of instruments and risk measurements. This primer assumes only a basic understanding of bonds and financial markets.
This note is split into two parts:
- Introduction to the concept of a yield curve and the three major sources of interest rate risk and return.
- Practical considerations for investors implementing yield curve strategies, including market themes and trade examples from recent years.