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Think of an IG bond purchase, financed at 3M Euribor, in an inverted curve environment.

The yield on the bond, Y, is below the 3M Euribor, at purchase.

The investor is looking to lock in a spread over the financing cost over the whole period of the bond investment, and has two options:

  1. Sell interest futures strips, roughly corresponding to the maturity of the bond. The TED spread (Y - Implied Strips Bond yield) is negative.

or

  1. Enter into an asset-swap, where they receive floating 3M Euribor and pay a fixed rate F, where F < Y.

If we assume only passage of time, and no other market variables change, what are the differences in return drivers from 1) or 2) after a time interval t, where t < bond maturity T ?

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    $\begingroup$ Swaps and Futures are derivatives. Their initial NPV is zero. If rates evolve exactly as expected their future NPVs are also always zero (netting any cash exchanges). There is no difference. If rates move and the IRS hedge is effectively the same in risk terms as the Euribor futures then they are the same. You have minor differences due to futures convexity and possible maturity mismatches but that does not seem to be the crux of your question. $\endgroup$
    – Attack68 ♦
    Commented Mar 1 at 15:27
  • $\begingroup$ @Attack68 - Yes, i am more interested in What happens with the return from everything else EXCEPT for price(rates) changes. $\endgroup$
    – A.S.
    Commented Mar 4 at 15:55

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