Bonds futures

Most techniques provide information only about one side of the surface-adsorbate bond. Future instrumentation developments aim for molecular level studies at buried interfaces, of both sides of the surface chemical bonds, and on an ever shorter time scale (time resolved studies). 

Jamshidian, F., 1996. Bond, futures and option valuation in the quadratic interest rate model. Appl. Math. Finance 3, 93-115. 

Government bond markets are closely related to other fixed income assets and interest rate and bond futures. This market is also increasingly related to the interest rate swap market. 

Questions such as the uses to which European bond futures can be put, contract specifications and trading volumes are discussed with illustrative examples. Technical issues, which surround the use of bond futures, are also examined and presented with numerical examples. The issues include the calculation of gross and net basis, identifying the cheapest-to-deliver (CTD) cash market bond, different approaches to measuring relative volatility, calculating hedge ratios, and portfolio duration adjustment. Bloomberg screen output is used to provide a real world flavour to the topics covered. 

The Bund future was launched on 29 September 1988. With the introduction of the German government bond futures contract LIFFE was now trading bond contracts in the US Treasury bond, the Japanese government bond, the Italian government bond and UK gilts. It was the first financial futures exchange to have achieved this position. The contract specifications on the UK and European bond futures offered at that time appear in Exhibit 16.1. 

In this section we address the following questions regarding government bond futures ... 

A variation on these futures contracts based on German Government paper is offered by Euronext Paris—MATIF. Both the Euro Notional Future, which covers the 8.5-10.5 year section of the yield curve and the 30-year E-Bond Future which covers the 25-35 year segment, allow delivery of either French or German Government bonds into the contract on settlement. 

Inside the Eurozone, the Spanish exchange MEFF Renta Fija in Barcelona offers a notional 10-year, 4% coupon Spanish government bond future and covers the 7.5-10.5-year cash market bond maturity range. It has a March, June, September, and December expiry cycle, a nominal contract value of 100,000, and a tick size of 1 basis point with a value of 10. The average open interest over the period 1 November 2002-29 November 2002 was relatively small at approximately 1,260. 

From the discussion above it is clear that the introduction of futures contracts on government bonds was strongly motivated by the need to hedge against increased market volatility. This remains one of the main functions of these instruments. The existence of bond futures, though, attract other desirable, indeed essential players, into the market place ... 

The contract specification of the Euro-Bund bond future introduces a concept of a notional bond. This is also true for all other bond futures contracts. For example, in the case of the UK gilt, the description of the futures contract bond is a 10-year gilt with a 7% coupon for the Euro-Bund future it is a 10-year German government bond with a 6% coupon the Spanish bond (bonos) future is a Spanish Government bond with a 4% coupon, and so on. 

Consider the opposite scenario, bond yields are expected to fall substantially and in the near future. In this case, the fund manager will be seeking to extend the maturity or duration of the bond portfolio. However, instead of adopting a physical bond-switching strategy government bond futures will be used. Here is such a scenario ... 

The question is how many bond futures need to be shorted to achieve the desired 25% reduction in weighting From the previous example, the BPV of the bond portfolio can be found by equation (16.15). In this case the BPV of the desired reduction will be given by... 

How does this bond option differ from, say, a bond futures contract bought at 98 The option confers a right, but not an obligation. This is the key difference between options and most other financial instruments. No one forces the holder of an option to exercise the right. He or... 

The buyer of a bond futures contract at 98 would also save 1 for every 100 face value of bonds, if these bonds eventually traded at 99. However, the buyer would not be able to benefit if the underlying bonds dropped to 97. He or she would still be obliged to buy them at 98. Futures—and similar financial instruments— lock the counterparties into a trade at a specific price. They confer a right, and an obligation, which must be honoured, whether or not it is financially advantageous. Options confer a right, but not an obligation—that s the key difference. 

DOHir 17.7 Trading Volumes for Eurex Bond Futures and Options on 7 March 2003 ... 

As explained in Chapters 19 and 16, swaps and futures contracts represent one of the easiest and most effective methods of managing a portfolio s duration exposure. Government bond futures is a frequently traded and extremely liquid contract in Europe, and investors can buy futures to increase duration, and sell futures to reduce the duration of their portfolio incurring minimal transaction costs. 

The products discussed include interest rate swaps, options, and credit derivatives. There is also a chapter on the theory behind forward and fiimres pricing, with a case smdy featuring the price history and implied repo rate for the CBOT long bond future. 

CASE STUDY CBOT September 2003 U.S. Long Bond Futures... 

For bond futures, the gross basis represents the cost of carry associated with the notional hond from the present to the delivery date. Its size is given by equation (6.7). 

Bond traders wishing to hedge the interest rate risk of their bond positions have several tools to choose from, including other bonds, bond futures, and bond options, as well as swaps. Swaps, however, are particularly efficient hedging instruments, because they display positive convexity. As explained in chapter 2, this means that they increase in value when interest rates fall more than they lose when rates rise by a similar amount—just as plain vanilla bonds do. 

An options payoff profile is unlike that of any other instrument. Compare, for instance, the profiles of a vanilla call option and of a vanilla bond futures contract. Traders who buy one lot of the bond futures at 114 and hold it for a month before selling it realize a profit if the contracts price at the end of the month is above 114 and a loss if it is below 114. The amount of the gain or loss is 1,000 for each point above or below ll4. The same applies in reverse to those with short positions in the futures contract. The futures payoff profile is thus linear, for both the long and the short position. This is illustrated in FIGURE 8.1. 

The option premium has two constituents intrinsic value and time value. Intrinsic value equals the difference berween the strike price and the underlying assets current price. It is what the options holders would realize if they were to exercise it immediately. Say a call option on a bond futures contract has a strike price of 100 and the contract is trading at 105. A holder who exercises the option, buying the futures at 100 and selling the contract immediately at 105, earns a profit of 5 that is the options intrinsic value. A put options intrinsic value is the amount by which the current underlying assets price is below the strike. Because an option holder will exercise it only if there is a benefit to so doing, the intrinsic value will never be less than zero. Thus, if the bond future in the example were trading at 95, the intrinsic value of the call option would be zero, not —5. 

Bonds. Exchange-traded options on bonds are invariably written on the bonds futures contracts. One of the most popular exchange-traded options contracts, for example, is the Treasury bond option, which is written on the Treasury futures contract and traded on the Chict o Board of Trade Options Exchange. Options written on actual bonds must be traded in the OTC market. 

In 1976 Fisher Black presented a slightly modified version of the B-S model, using similar assumptions, for pricing forward contracts and interest rate options. Banks today employ this modified version, the Black model, to price swaptions and similar instruments in addition to bond and interest rate options, such as caps and floors. The bond options described in this section are options on bond futures contracts, just as the interest rate options are options on interest rate futures. 

Options price sensitivity is different from that of other financial market instruments. An option contract s value can be affected by changes in any one or any combination of the five factors considered in option pricing models (of course, strike prices are constant in plain vanilla contracts). In contrast, swaps values are sensitive to one variable only—the swap rate—and bond futures prices are functions of just the current spot price of the cheapest-to-deliver bond and the current money market repo rate. Even more important, unlike for the other instruments, the relationship between an option s value and a change in a key variable is not linear. 

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