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arbitrage -- for the short length of time that the forward
contracts remained outstanding -- changes or shifts in the
interest and discount rates associated with the particular type
of Government securities to which the forward contracts were
pegged. By entering into offsetting forward contracts to
purchase and to sell these Government securities, Holly
effectively created synthetic short-term security investments by
means of the straddles, even though the underlying Government
securities to which the interest rate speculation was pegged
constituted long-term Government securities.
For example, by entering into a contract to purchase, at the
current market or other specified price, 15-year T-Bonds for
delivery in 3 months and simultaneously entering into a contract
to sell, at the current market or other specified price, 15-year
T-Bonds for delivery 6 months later, Holly "created" the economic
equivalent of a contract to purchase a 6-month T-Bond. Holly
then arbitraged these contracts against simultaneous contracts to
sell GNMA’s on the same specified date in 3 months and to
purchase GNMA’s 6 months later.
In economic terms, and as between the parties, the only
important factors in such a straddle transaction are the
initially specified price differential between the legs of the
forward contracts or straddle and changes in interest and
discount rates associated with the particular Government
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Last modified: May 25, 2011