Matrix trading is a strategy that involves swapping bonds that have different ratings or classes. Normally there is a clear relationship between the risk of a bond and the return it offers. Matrix trading is designed to take advantage of temporary disparities in this relationship.
The basis of matrix trading is the bond. This is a type of investment that involves an original buyer effectively lending money to a company or a government, with the bond later redeemed on a set date and repaid along with a fixed rate of interest. The bond may change hands on the open market several times, meaning a different person winds up redeeming the bond. The price of a resold bond will depend on factors such as how desperate the buyer is to cash in, and how well the interest rate on the bond compares with other forms of investment available at the time.
Different bonds have inherently different levels of risk. For example, a government is much less likely to default on a bond repayment than a company, which may go out of business before the redemption date. Similarly, a strong, well-established company is more likely to repay than a company involved in a risky business.
Under normal circumstances, this varying risk is reflected in the yield. This is the amount of profit the holder will make by keeping the bond until its redemption date. This initially is determined by the issue price of the bond, though individual investors who buy it later will have a different yield figure depending on the price agreed in their specific trade. In most cases, somebody talking about the yield of the bond will mean the average yield available to people buying a bond at the current market rate. The yield usually will be higher for bonds ranked as more risky.
Matrix trading involves monitoring the yield for different types of bonds and finding situations when the difference between the yields does not follow a standard pattern. People using matrix trading work on the assumption that this is caused by a temporary factor, such as a company defaulting on a bond and causing panic among holders of other similar bonds, and will eventually correct itself. These investors will attempt to take advantage either by buying, selling, or swapping bonds. Sometimes, the aim is to make cash this way, but in many cases, the aim is simply to get a bond that offers an unusually high yield given the inherent risk.
