Reply #12: There is more to the story...

[dkf]

If anything this was a financing position (or liquidity trade) — not a bet on the future direction of the bonds themselves.

What’s more, if executed properly the trade should — at least on paper – have posed little or no risk.

The maths was simple enough. You account for the cost of borrowing funds using the bonds in question as collateral (the repo rate) versus the ultimate coupon payments received from the very same bonds.

This is because  in dysfunctional markets the repo rate can be out of kilter with the ultimate returns of the bond itself. This is especially the case if there are more counterparties willing to provide short-term liquidity in return for rates that beat the nominal risk-free return.  In other words to act as pawnbrokers to the market. Alternatively, if you have a good credit standing in the market you may be able to achieve a more favourable repo rate than others.

http://ftalphaville.ft.com/blog/2011/10/31/717181/mf-gl... /

--the trade fell apart