Suppose, swap-spreads went up to historical highs and LTCM believed they would come back down so they entered a "short" swap-spread position, which is the opposite position as the one described in the Swap-spread example (that is they shorted treasuries and received fixed on swaps). Suppose the 10-year swap spread was 50 basis points and LIBOR was 20 basis points over the repurchase rate. Assuming the spread between LIBOR and the repurchase rate stays steady over time, what are the cash flows from interest and swap payments generated from this trade (i.e, the theoretical cash flows ignoring margin calls or any mark-to-market value changes)? What risk is there to these cash flows if LIBOR changes relative to the repo rate?

Answer rating: 100% (QA)

In a short swapspread position LTCM is essentially betting that swap spreads will decrease meaning that the difference between the fixed rate paid in ... View the full answer