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An Arbitrage Opportunity in the Futures Market: The ECB’s Quantitative Easing Program
Tomio, Davide; Fernstrom, Aaron Case F-2080 / Published August 28, 2024 / 14 pages. Collection: Darden School of Business
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Product Overview

In early 2016, Tommaso de Marchi identified a potential arbitrage opportunity in the futures market due to the European Central Bank’s (ECB’s) quantitative easing (QE) program. The ECB’s bond purchases had significantly increased bond prices, presenting a chance to make riskless profit by exploiting price discrepancies between bonds and futures. De Marchi, a market maker, needed to evaluate whether to engage in the trade (considering its risks and return) and whether disposing of his inventory could undermine his role of liquidity provider. To maximize profitability, he also needed to determine which bond from the delivery basket for the March 2016 futures contract would be the cheapest to deliver (CTD). De Marchi’s strategy involved borrowing the CTD bond through the repurchase (repo) market, where transactions were typically overnight, requiring a continuous borrowing process until the futures contract’s delivery date. The first risk he faced was that the cost of borrowing the bond might become prohibitively high during the life of the trade. He was concerned about the unpredictability of the ECB’s actions, which could impact bond prices if QE purchases ceased or if the ECB sold its holdings. Additionally, he needed to manage the intricacies of the bond prices, conversion factors, and repo rates. Despite these risks, the potential for locking in a profit in a low-interest-rate environment was compelling. This case introduces the students to financial and fixed-income derivatives and uses law-of-one-price arguments as a starting point from which to explore the mechanics, costs, and risks of arbitrage strategies involving trading offsetting quantities of a derivative and its underlying asset. The case presents a true-to-life example of basis and invites students to consider the meaning of basis and the risks of a basis trade. The setting of the ECB’s QE efforts allows the instructor to touch upon the concept of asset scarcity and link it to the effects of large-asset purchase programs on absolute and relative asset prices. This case has been successfully taught at the University of Virginia Darden School of Business in the “Derivative Securities: Options and Futures,” a second-year elective course in the MBA program.



Learning Objectives

The case can be used to pursue the following objectives: (1) Introduce futures contracts that have a financial asset as their underlying asset (specifically sovereign bond futures) and cover their pricing. (2) Highlight how the prices of futures contracts and their underlying assets can deviate, giving rise to a basis, and how investors can take advantage of the mispricing. (3) Introduce how repo markets are used to fund positions and locate securities for shorting, and how repo transactions may pose risk to and increase costs faced by arbitrageurs. (4) Discuss the impact of QE on asset prices and market functioning.


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  • Overview

    In early 2016, Tommaso de Marchi identified a potential arbitrage opportunity in the futures market due to the European Central Bank’s (ECB’s) quantitative easing (QE) program. The ECB’s bond purchases had significantly increased bond prices, presenting a chance to make riskless profit by exploiting price discrepancies between bonds and futures. De Marchi, a market maker, needed to evaluate whether to engage in the trade (considering its risks and return) and whether disposing of his inventory could undermine his role of liquidity provider. To maximize profitability, he also needed to determine which bond from the delivery basket for the March 2016 futures contract would be the cheapest to deliver (CTD). De Marchi’s strategy involved borrowing the CTD bond through the repurchase (repo) market, where transactions were typically overnight, requiring a continuous borrowing process until the futures contract’s delivery date. The first risk he faced was that the cost of borrowing the bond might become prohibitively high during the life of the trade. He was concerned about the unpredictability of the ECB’s actions, which could impact bond prices if QE purchases ceased or if the ECB sold its holdings. Additionally, he needed to manage the intricacies of the bond prices, conversion factors, and repo rates. Despite these risks, the potential for locking in a profit in a low-interest-rate environment was compelling. This case introduces the students to financial and fixed-income derivatives and uses law-of-one-price arguments as a starting point from which to explore the mechanics, costs, and risks of arbitrage strategies involving trading offsetting quantities of a derivative and its underlying asset. The case presents a true-to-life example of basis and invites students to consider the meaning of basis and the risks of a basis trade. The setting of the ECB’s QE efforts allows the instructor to touch upon the concept of asset scarcity and link it to the effects of large-asset purchase programs on absolute and relative asset prices. This case has been successfully taught at the University of Virginia Darden School of Business in the “Derivative Securities: Options and Futures,” a second-year elective course in the MBA program.

  • Learning Objectives

    Learning Objectives

    The case can be used to pursue the following objectives: (1) Introduce futures contracts that have a financial asset as their underlying asset (specifically sovereign bond futures) and cover their pricing. (2) Highlight how the prices of futures contracts and their underlying assets can deviate, giving rise to a basis, and how investors can take advantage of the mispricing. (3) Introduce how repo markets are used to fund positions and locate securities for shorting, and how repo transactions may pose risk to and increase costs faced by arbitrageurs. (4) Discuss the impact of QE on asset prices and market functioning.