Bund futures

During 2002 Bund GC traded in a range around 2-10 basis points below EURIBOR in the short dates, while on occasion trading in specials went down to 90 basis points below the GC rate. As in other markets, there are a number of reasons why government stocks become special in the German market however, the primary factor is the extent of its deliverability into the Bund futures contract. For illustration we show, in Exhibit 10.23, the spread below GC for repo in the DBR... 

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. 

LIFFE s Bund future was a story of success. Eollowing its release, this contract powered ahead of the volnme in gilt trading in its first full year of trading. Exhibit 16.2 illustrates this point and the tremendons interest in the Bund contract compared to the gilt at least np nntil the end of 1997. 

As an alternative to Eurex s 10-year Euro-Bund future, Euronext LIFFE offers a similar contract again based on a nominal 100,000 contract size, tick value of 10, and the same expiry cycle. The Euro-Schatz counterpart, however, offers a contract size of 200,000. The smallest allowable price movement is one half of a basis point and hence the value of a tick remains at 10. 

The action undertaken by the portfolio manager is then as follows. Assume that the cash market bond held in the portfolio is deliverable into a futures contract and is a natural candidate for hedging using the Euro-Bund futures contract on Eurex-Deutschland. The contract specification appears in Exhibit 16.6. 

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. 

In other words the 7% gilt, the 6% Bund, and the 4% bonos around which the futures contracts are constructed do not exist. A cash market bond that can be delivered into the contract on maturity has to be identified and converted to match the futures contract specification. In full exchange-based contract specifications, the list of deliverable cash market bonds are well defined and are restrictive. Deliverable bonds in the case of the Bund future will be bonds issued by the Federal Government of Germany and will have a maturity between 8.5 and 10.5 years. Normally, bonds offering early redemption, floating coupons, or some form of convertibility will not be in the list of deliverables. 

A numerical example will help to clarify the method. The data in Exhibit 16.8 are daily observations, drawn from Bloomberg, on the Euro-Bund Futures quotes and CTD yield-to-maturity over a period of 12 days. Columns (4) and (5) display the changes in futures quotes and yields, respectively, that have taken place from one day to the next. Using the data in columns (4) and (5) equation (16.10) can be estimated using least squares regression. ... 

The portfolio is valued at 100,000,000 and has been constructed to track a bond index for which the Euro-Bund Future is a very good hedge instrument. The basis point value (BPV) of the Euro-Bund futures contract is 72.03 and the yield is 5.595% calculated on an annual 360-day year basis. The bond index, which the portfolio has been designed to track, is quoted at 117.80. 

The bond portfolio has the following characteristics Modified duration is 7.4908 yield is 4.595%, current valuation is 300,000,000. The BPV of the Euro-Bund future is 72.03. 

Dividing this by the BPV of the Euro-Bund future will determine the number of contracts to short ... 

The above examples have focused on the use of the Euro-Bund future as a vehicle for achieving a particular bond portfolio exposure. As indicated earlier, there are several other futures contracts available in the European arena and these could be used in the same way as described above. The futures contracts could also be used to alter the maturity characteristics of the portfolio by using, for example, futures contracts constructed around shorter or longer dated instruments than those currently held in the portfolio. The fact that the contracts can be bought or sold on margin, that the major contracts are liquid and span the European markets, and their flexibility of use make them essential financial market instruments. 

Options on Euro-BUND futures (OGBL). The BUND future is a contract on a notional long-term instrument issued by the German Federal Government with a remaining time to maturity between 8.5 and 10.5 years, bearing a 6% coupon. 

At the time, the June 2003 Euro-BUND future is trading at 116.42, and the cheapest-to-deliver (CTD) bond for the June 2003 futures contract is the 5% bond maturing on 4 January 2012, and having a conversion factor of 0.9341. The PVBP (or DVOl) for the CTD bond is 0.0788, while that for the bond actually held is 0.0840. The hedge ratio for the bond portfolio is therefore... 

As mentioned in the introduction of this chapter, the option on the Euro-Bund futures is an extremely popular contract. Exhibit 18.1 presented an example of the contract specification drawn from a Bloomberg screen. Exercise of these options entails taking a position in an underlying Euro-Bund Futures contract which will involve taking or making delivery of a physical bond should the futures contract be held until maturity. 

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