Earning interest by shorting bonds is ridiculous

CFA Level III
#1

How can you earn a return on the treasury bill by creating a treasury bill? You would have to pay it out, wouldn’t you? (And that will cancel the risk-free portion of your MBS yield, leaving you earning only the spread.)

What am I missing? See quote below.

“The interest rate risk of a mortgage security corresponds to the interest rate risk of comparable Treasury securities (i.e., a Treasury security with the same duration). This risk can be hedged directly by selling a package of Treasury notes or Treasury note futures. Once a portfolio manager has hedged the interest rate risk of a mortgage secu- rity, what can the manager earn? Recall that by hedging interest rate risk, a manager synthetically creates a Treasury bill and therefore earns the return on a Treasury bill. But what still remains after the interest rate risk is removed is the spread risk which, as just explained, is not hedged away. So, the portfolio manager after hedging interest rate risk can earn the Treasury bill return plus a spread over Treasuries. However, a portfolio manager cannot capture all of this spread because some of it is needed to cover the value of the homeowner’s prepayment option. After netting the value of the option, the portfolio manager earns the Treasury bill rate plus the potential to capture the OAS.”

(Institute 154) Institute, CFA. Level III 2013 Volume 4 Fixed Income and Equity Portfolio Management. John Wiley & Sons (P&T), 6/18/2012. vbk:9781937537364#page(154).

#2

Keep the following relationship in mind: Value of MBS = Value of Treasury - Value of Prepayment Option

You can hedge the interest rate risk of an MBS by using a two-bond hedge - one solution to this is to simultaneously short two packages of Treasury futures. Assuming you have built the correct hedge to eliminate the level and twist of interest rate movements, you have effectively hedged away all price sensitivity from the Treasury portion of the MBS (see above).

Keep in mind that Treasury futures do not make coupon payments. Since you are long a treasury in the MBS relationship above, the return you get from hedging away price risk is the coupon (what I assume they are referring to as the Treasury bill return in the text).

What is left is spread typically associated with option and model risk. The manager is seeking to earn this spread based on their individual rate/volatility forecasts - i.e., increasing MBS allocation when spreads widen and decreasing MBS allocation when spreads tighten.