Bond Futures

1
Bond Futures

• October 2, 2001

2
Treasury Bill Futures

• Trade on IMM
• Agreement to deliver Treasury bill with 13 weeks
  remaining until maturity and face value of 1
  million.
• The Treasury bill can be seasoned or newly issued.

3
Treasury Bills

• Quoted in cash market in terms of annualized
  yield on bank discount basis
• Where D is the dollar discount, or face value
  price of Tbill maturing in t days.

4
Treasury Bill Futures

• Price is not quoted in terms of yield, but on
  index basis related to yield on bank discount
  basis

5
Eurodollars

• Eurodollar certificates of deposit
• Denominated in dollars but represent liabilities
  of banks outside the U.S.
• Traded on IMM of CME and LIFFE
• Rate paid LIBOR

6
Eurodollar Futures

• Underlying is 3 month Eurodollar CD
• 1 million face value
• Traded on index price basis
• 100 annualized futures LIBOR
• Settled in cash, based on value of Eurodollar CD
  using LIBOR on settlement date
• Heavily traded

7
Treasury Bond Futures

• Traded on CBT
• Underlying is 100,000 par value of hypothetical
  20 year 6 coupon rate
• Quotes are in 32nds of 1 percent
• Minimum price tick 32nd of 1 or 31.25
• Futures price quoted with par 100

8
Deliverable Instrument

• Issue must have at least 15 years to maturity
  from date of delivery if not callable, and be not
  callable for at least 15 years from first day of
  delivery month.
• Implies a wide range of deliverable instruments.

9
Conversion Factor

• A factor used to equate the price of T-bond and
  T-note futures contracts with the various cash
  T-bonds and T-notes eligible for delivery. This
  factor is based on the relationship of the cash
  instrument coupon to the required 6 percent
  deliverable grade of a futures contract.

10
Tbond Futures Invoice Price

• Invoice price settlement futures price
  accrued interest
• Must be adjusted for actual Treasury issue
  delivered.

11
Cheapest to Deliver

• Implied repo rate buy issue and deliver it at
  settlement rate.
• Cheapest to deliver has highest implied repo
  rate.
• Delivery Options
• Timing option
• Wild card play

12
Treasury Note Futures

• Modeled after Treasury bond futures and traded on
  CBT.
• 10 year 100,000 par value of hypothetical 10
  year 6 percent Treasury note Maturity not less
  than 6.5 years, and not more than 10 years
• 5 year Maturity between 4 years, 3 months an 5
  years, 3 months
• 3 year 200,000, between 1 yr 9 months and 2
  years

13
Theoretical Futures Price

• Can be determined from
• Price of bond in cash market
• Coupon rate of bond
• Financing rate
• A Strategy
• Sell futures contract at F
• Borrow P at rate r until settlement date
• Purchase bond for P
• FP1t(r-c)
• c is current yield

14
Cost of Carry

• Theoretical futures price may be at a premium or
  discount relative to cash price, depending on r-c
• r-c net financing cost
• Positive carry current yield earned gt financing
  cost
• Negative carry current yield earned lt financing
  cost
• Carry depends on shape of yield curve

15
Futures Price

• FP1t(r-c) delivery options
• Bond choice
• Timing
• Wild card
• Borrowing and lending rates not equal
• Upper bound on price related to borrowing rate
• Lower bound on price related to lending rate

16
Speculation

• Price of interest rate futures moves in opposite
  direction to interest rate
• Speculate that rates will rise sell interest
  rate futures
• Advantages of using futures market
• Transactions costs of lower
• Margin requirements are lower
• Easier to short sell

17
Interest Rate Risk

• Alter interest rate sensitivity of portfolio
• Expect rates to increase shorten duration of
  portfolio
• Construct portfolio with longer duration than
  available with cash instruments

18
Synthetic Securities

• Own a 20 year Tbond short a futures to deliver
  that bond 3 months from now.
• Combination effectively shortens maturity of bond
  equivalent to long position in 3 month riskless
  security.
• RSP CBP - FBP