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There have been numerous headlines the past two years where we learn that quant funds are engaging in algorithmic basis trades (aka relative value trades) between Spot Treasuries and Treasury Futures, and that this is a rather large market ~$1 Trillion.

The returns on this arbitrage are of the order of a few bps. However, with Repo leverage, those returns are goosed up to make it worthwhile apparently.

If the Repo rate is of the order of the Fed Funds Rate, how can this be worthwhile? FFR currently is 9bps. If you borrow money via Repo at 9bps, how can you chase a return lower than that in basis trades?

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They mean the return after repo costs.

So for example, if you can buy the bond and sell the future for an implied rate of financing of 15bp and the market charges you 12bp, you will make 2bp on the trade with the only risk being counterparty failure. (assuming you can lock repo and borrow). Now you will have to put up collateral, so you have to figure out what's the value of that to you/your investors. You might get 30:1 leverage, so with \$100 you can buy/finance \$3,000 worth of bonds. Then you get a 60bp return. Not great, but better than nothing.

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  • $\begingroup$ Are haircuts on Repo delivering 30:1? I thought haircuts were more of the order of 8%? $\endgroup$
    – Kiers
    Commented Dec 24, 2021 at 19:12
  • $\begingroup$ I think the original question was regarding Treasuries? The haircut will depend on the collateral and relationship with the borrower. $\endgroup$
    – JoshK
    Commented Dec 27, 2021 at 23:59

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