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This is a 1-year forward, 2y - 5y steepener trade.

How is this executed? Are actual Treasury bonds involved or are these just forward contracts between two parties?

Is the trade expressing the fact that 2y - 5y curve is flat looking 1 year forward? How can one express a view on the curve 1 year forward, 2 year forward, 3 year forward, etc...It seems like the further you go out in forward space, the more uncertainty you have.

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To do such a trade would require selling a 6 year Treasury , and buying a 3 year Treasury, both with a settlement date of one year from now. This is actually hard to do in practice, since not many dealers offer such long settlement dates for Treasury transactions.

It is much easier to do this trade in interest rate swaps , where you can easily do a 1yr-5yr forward swap versus a 1yr-2yr forward swap. One would pay fixed on the former and receive fixed on the latter, in duration equivalent amounts.

These trades are often done to take advantage of the fact that the yield curve implies that it will be flatter in the future. For example the slope (5yr-2yr) may be 25bp on a spot basis but only 10bp on a 1yr forward basis. Thus, you would do the trade if you believe the spot spread one year from now will still be 25bp.

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Suppose the following (incorrectly simplified) DV01s:
1Y 1mm = 100,
2Y 1mm = 200,
3Y 1mm = 300,
4Y 1mm = 400,
5Y 1mm = 500,
6Y 1mm = 600,

To execute a short in 500 dv01 of a 1Y5Y you need to sell 1mm 6Y and buy 1mm 1Y. This gives you forward bond exposure.

To execute a long in 500 dv01 of 1Y2Y you need to buy 2.5mm 3Y and sell 2.5mm 1Y.

The combination of the above is: sell 1mm 6Y, buy 2.5mm 3Y and sell 1.5mm 1Y. You will observe the total DV01 = zero.

If you executed the above in par swaps it would amount to the same forward risks, the only difference being in swaps you can also trade the forwards directly.

The other point to note is that you would have to fund the positions in bonds with o/n repo. If you have sold some bonds that might go special on repo this might amount to a considerable cost-of-carry.

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