IC301
Bond futures
Bond futures are financial derivatives which obligate the contract holder to purchase or sell a bond on a specified date at a predetermined price.
Quotation: in percent of par to the nearest 1/32nd of 1% of par
Can be used for hedging, arbitrage or speculation
US Treasury securities with at least 15 years and less than 25 years to maturity are deliverable into a $100,000 futures contract size describe:
A) 5-Year Notes
B) 10-Year Notes
C) Classic T-bond
D) All the above
Answer: C
2
A US Treasury note futures quote of 101-20 is equal to:
A) 101.064
B) 101.20
C) 101.3125
D) 101.625
Answer: D
20/32=0.625
On-the-run and off-the-run securities
On-the-run securities Off-the-run securities
Most recently issued
Most liquid -> liquidity premium
Normally trade at premium -> lower yield
The most actively traded
Issued before the most recent ones and are still outstanding
Higher yield than on-the run
What is the main difference between on the run and off the run Treasury securities?
A) The on the run is the most recent issue
B) Off the runs are less liquid
C) On the runs can trade at a slightly lower yield and higher price due to a liquidity premium
D) All the above
Answer: D
Bond future buyer = an agreement to lend money in the future
Bond future seller = an agreement to borrow money in the future
Most recent settlement price* Conversion factor
+ Accrued interest
For a classic T-bond, any government bond that has between 15 and 25 years to maturity can be delivered
What is a conversion factor?
The underlying on T-Bond futures is a theoretical, 20-years-to-maturity, 6% coupon Treasury bond. As it’s difficult to find such a bond in circulation, the short is allowed to deliver any Treasury bond with at least 15 years to maturity.
High-coupon securities will naturally command a greater price than comparable low-coupon securities. Therefore, a conversion factor is used to converts all securities to the 6% coupon.
Basis
Cash price – conversion * future price
Basis is defined as the difference between the clean price of the cash security minus the converted futures price.
https://www.cmegroup.com/education/courses/introduction-to-treasuries/the-basics-of-treasuries-basis.html
9
Cheapest-to-deliver (CTD)
As traders who are short can choose which Treasure bond to deliver at maturity, they would need to know which one is the cheapest to deliver
Net Basis Implied repo rate
Basis = Cash price – adjusted Futures price
Basis = delivery cost = Cash price – future price*conversion factor
The lowest basis = CTD
IRR – theoretical yield produced by buying the cash security, selling the futures contract, lending the cash security in the repo market and finally, delivering the security into the futures contract on last delivery day.
The highest IRR = CTD
Which of the following is NOT an option open to the party with a short position in the Treasury bond futures contract?
A) The ability to deliver any of a number of different bonds
B) The wild card play
C) The fact that delivery can be made any time during the delivery month
D) The interest rate used in the calculation of the conversion factor
Answer: D
Wild card play
A right of a short T-Bond holder to deliver after the closing price has been set, even if it is not trading anymore
Can benefit if there is a shift in the value between the time of closing price and actual delivery
Gives the seller an opportunity to deliver CTD regardless its closing price
The cheapest to deliver (CTD) has
A) The lowest basis
B) The lowest implied repo rate
C) The most recent issue date
D) The closest price to the futures contract
Answer: A
13
If a US Treasury trader is long 10 Year notes and they sells 10 Year note futures against the position, they are:
A) Completely perfectly hedged
B) Long the basis
C) Short the basis
D) Have two separate unrelated trades
Answer: B
The implied repo rate is:
A) Lowest with the lowest basis
B) Highest with the lowest basis
C) The negative carry from making delivery
D) Depends on the funding rate
Answer: B
The CTD is usually delivered against the short bond futures position because:
A) It is the cheapest bond to deliver
B) It has the least loss from delivery process
C) It has the highest implied repo rate
D) All the above
Answer: D
The most recent settlement bond futures price is 103.5. Which of the following four bonds is cheapest to deliver?
A) Quoted bond price = 110; conversion factor = 1.0400.
B) Quoted bond price = 160; conversion factor = 1.5200.
C) Quoted bond price = 131; conversion factor = 1.2500.
D) Quoted bond price = 143; conversion factor = 1.3500.
Answer: C
The cost of delivering a bond is the quoted bond price minus the most recent settlement price times the conversion factor. This is 2.36, 2.68, 1.625, and 3.275 for bonds in A, B, C, and D, respectively. The bond in C is therefore cheapest to deliver.
Cheapest-to-Deliver Bond
Because the party with the short position receives
Most recent settlement price * Conversion factor + Accrued interest
and the cost of purchasing a bond is
Quoted bond price + Accrued interest
the cheapest-to-deliver bond is the one for which
Quoted bond price – (Most recent settlement price*Conversion factor)
is least
What is duration hedging?
Duration: the sensitivity of the bond price to the change in interest rates
Duration hedging: using CTD T-Bonds to hedge against the shifts in interest rates
A portfolio is worth $24,000,000. The futures price for a Treasury note futures contract is 110 and each contract is for the delivery of bonds with a face value of $100,000. On the delivery date the duration of the bond that is expected to be cheapest to deliver is 6 years and the duration of the portfolio will be 5.5 years. How many contracts are necessary for hedging the portfolio?
A) 100
B) 200
C) 300
D) 400
Answer: B
The contract price is 110,000.
The number of contracts is (24,000,000×5.5)/(110,000×6.0)=200