Fixed Income: Perception is Reality
Reference is Handbook of Fixed Income Securities by Fabozzi.
When we look at bonds we look at yields to maturity to find out what return we would get if we held the bond to maturity given the price we have to pay to purchase the bond. There is a yield curve of differing returns to differing tenors of bonds. It seems logical that longer term bonds may be more illiquid because you have to tie up your money for longer and there is a risk premium for that so the yield curve is upward sloping or tends to be. The critical factor with fixed income trading is that perception makes reality as the interest rates themselves are determined by supply and demand for treasury bonds and whichever type of bond you are looking at. If perception moved in a way that your bonds get overvalued then your interest rate will fall and you will attribute your long bond profits to a fall in interest rates but really it was supply and demand and perception that moved the price. This differs from the stock market where earnings each quarter sends strong signals about the success or failure of a stock. Generally bonds are far from default risk unless they are junk bonds and the price moves on interest rates which has mathematics behind it in that you can imply forward rates for example but it is rather the layers of perception at each time tenor that work together to imply an overall dream which is the yield curve.
For instance take the American dream, it may start with a bunch of colonists from all around the world who train together at a hedge fund until they resemble the United Nations. Then America and Israel start to deviate from the world consensus as America repeatedly vetoes resolutions condemning Israeli settlements let’s say. The dream begins to dissipate as supply and demand for social interaction shifts until interest rates move in such a way to force you to sell your long bond because interest rates grow very high for example and it becomes prohibitive to borrow favors from your friends so you just stop interacting with people which is in effect the dumping of your American dream.
Now in the wake of this dream, interest rates are high because you dumped your bonds at a low price and whoever steps in gets a nice dream until the bonds go to maturity. The next dream is British Empire and involves building yourself as Canada to reflect an early childhood in that northern nation and as that dream progresses rates fall as supply and demand shift to create a bubble in your bond and you happily earn profits on paper. However the War of 1812 ensues and your girlfriend plays as America while you play as Canada and you can barely defend yourself and ask for British help. She hurts herself while cooking and you are at work and you realize you don’t really want to hurt her and you ask the British to stand down while you drop your responsibilities and head home. Supply and demand for your bonds shift as peace ensues and people put their money they would have spent on buying bonds into buying higher returning and riskier stocks now that there is peace and it is overall safer. Your bonds fall in supply and demand as your desk turns their attention to other recruits say from India British Raj. Your dream ends as you are forced to dump your bonds again on losses as you can’t meet margin calls to hang onto your position. The impetus to finally dumping your bonds is the vast gap between economic development in your girlfriend’s America and your own Canada which has led to capital flight to America in a way that no one is willing to lend you money to maintain your margin positions on your bonds.
As your bonds are dumped again someone else ventures to buy your bonds and this time it is someone else’s money supporting your dream as a courtesy from above. This time it is the Dixieland dream. Jefferson Davis calls on William Gladstone from the United Kingdom as Prime Minister to praise the south as the Prime Minister says whatever you think of the south, Jefferson Davis has built an army, is building a navy and has built something greater than both which is a nation. This dream collapsed on Pickett’s Charge at Gettysburg as things had gotten worse and worse with rates rising and distrust rising basically and Pickett’s Charge tried to challenge the basis of Mark to Market accounting instead of what he preferred as Mark to Model accounting on structured fixed income instruments. It fails, the drive to pump up demand for the bonds fail and your sponsor dumps the bonds and you are left with the scraps of someone else’s dream for you the remains of his charity and before you charged you had met with Abraham Lincoln himself to ask why the company was fighting itself and he had responded: Alex it is all a dream as corporate politicians are amateurs.
Instead of these dreams if we move out of perception which lasted for years, I was involved in fixed income primarily in the credit space making quantitative bets using ordinary differential equations that check for rates of speed, acceleration and jerk. You can say I was building a pod racer in Star Wars while I was dreaming all these dreams and then the last dream I dreamed was when I woke up as Qui Gonn the freestyle Jedi as I just had a premonition that a podcar would be important while I worked at the Jedi Academy. In short, after you win there is one story which confirms your experience but if you lose all your experiences are falsified. It is assymetric. And as thus my loyalty to the United States, I declared fixed income trading less of trading than of surviving the dreams that impart upon you while you trade as those dreams are shared on a desk that shared profit and loss and divides salary and dreams are very real when shared. If you keep winning your experiences keep confirming until you wake up from reality and that isn’t nirvana but the stage beyond agnosticism which I will call Homo Religious as you begin to see religion in the design of the world. So in a way we can say religion is self confirming provided you win. Who are you playing against? Yourself. As I have finally beat my own shadow: I am an American who has outcompeted the Chinese Dream and though all of you will tell me I am dreaming that I’ve won, I only tell you the only proof you need is like a fixed income bond, not the price change which is small and hard to calculate on billions of notional but instead look at the interest rate. I was short bond this time and the interest rate spiked. Distrust spiked. Social ostracization ensues. But I’m not long a bond and I am not dreaming. I am short a bond and I am fueling a dream for someone else. That person lost if they were long but I provide the dream even if she cannot hold onto the bond as I use my profits to support her position by reducing my short stake as profits come in. This changes supply and demand in her favor as I am a large player on this bond I cornered the market in. What bond is this? River dance is for lionesses. And the American tigers hold sway over the field today. The winged tiger in your dreams. United States Air Force. No one is even close. And to the ladies of Chicago. To the Emerald City, California seems like Dixieland and Chicago seems like the Inception of Boston. We are all in one country not separate cities. And whatever your accent, you are welcome if to death do us part. Rule Britannia and America the Beautiful, as I think male tigers are already overly colourful, I think I could use a British accent or otherwise could use a way to dry things up and sorry Canada sparkle someone else’s eyes. We celebrate the return of United Kingdom to the American Empire. And onward the pioneers to have our wealthiest territory but with per capita income of Alabama in many cities, join us as British Commonwealth near Seoul of Asia as I look Asian but bleed American and see with azure mist over my eyes. Bewitched by glowing hazel eyes perhaps or perhaps just home for the holidays the dream of the great Beatles Invasion also passed and what we have left is what we believe. I believe it is time to leave Seattle to return to Philadelphia. Enchanted I am and however Grendel’s Mother is doing in Philadelphia, I just ask us to recognize I did it all on faith and we need reason. Faith is not just religion but endurance. Faith is an ecosystem. I had a desert. My only friend. Now I have a resource poor island and I shoot back in time to become an Asian man again as only an Asian man has a chance with girls who like Asian men. Real heroes don’t wear capes. Thank you the royal blue guard on America who don’t guard the king as the strongest among us may not wear a crown but guard the fair as well with manly hearts or hearts of oak rooted with each blast more firmly in thy native rock, where I have withstood the shock of the fall of England, Denmark, Rome and the world in Scotland the Brave. In this town the American revolution when men of Acton marched to Concord Bridge in 1776 about circumstances involving a world of hurt that the Duchess of Devonshire would go through in her dreams. It is all forgotten but what remains is the ground beneath her feet which I love per an island far away called Troy where this all started, Chicago hard to say I’m sorry the song for quitting last time. A song with words but an ode to the nightingale, come now we must hurry to save Canada where I am a citizen.