A bond futures contract allows a trader to speculate on the price movement of a bond and set a price for a specific future period. If a trader has bought a bond futures contract and the price of the bond has risen and closed higher than the contract price when it expires, the trader has a profit. At this point, the trader could accept delivery of the bond or balance the buy transaction with a sell trade to settle the position with the net difference between the prices settled in cash. • The average transaction size in terms of risk is much higher for current securities than for futures. This is likely due to the higher prevalence of automated trading in futures markets, which in turn leads to the breakdown of futures trades into smaller orders for execution. The objective of this note is to present a liquidity hierarchy by comparing the volume traded through the cash and futures contract compartments just described. However, to make the comparisons most meaningful, the size of the transaction is converted into an amount equivalent to the risk, i.e. the amount of interest rate risk transferred through trading. Where two counterparties enter into a bond futures contract, they shall agree on a price at which the long-term party – the buyer – buys the bond from the seller who has the option of the obligation to be delivered and when, during the month of delivery, the obligation is to be delivered. Suppose a party runs out – the seller – a 30-year Treasury bond, and the seller has to remit the Treasury bond to the buyer on the specified date.
The risk of trading bond futures is potentially unlimited, whether for the buyer or seller of the bond. Risks include that the price of the underlying bond changes dramatically between the exercise date and the date of the original agreement. The leverage used in margin trading can also exacerbate losses in bond futures trading. Bond futures are contractual arrangements in which the asset to be delivered is a government bond. Bond futures are normalized by futures exchanges and are among the most liquid financial products. A liquid market means that there are a lot of buyers and sellers, which allows the free flow of business without delay. The DV01 volume of individual futures and spot securities increases mainly with volatility. And the entire volume DV01 on all instruments on days of high volatility – 90.
Percentile – is on average more than twice as high as volume on low volatility days – 10th percentile. However, the present note focuses on the relative volume of all instruments. ↵10 This is a simplification for two reasons. First, the bonds that are actually delivered may not be CTD bonds, as futures contracts have built-in delivery options. However, during the sampling period, the values of these delivery options were very low because interest rates were very low compared to the nominal coupon of futures. Second, the DV01 of the futures contract is approximated closer to the expiry date of the contract by the converted DV01 from a forward position in the CTD. However, the relevant term period is short and less than 6 months at any given time, as only the two contracts before each term are used in this study. In addition, no data are available on the share of the volume of treasury operations executed with repurchase agreements, which would convert this volume of cash into futures contracts.
Bond futures are financial derivatives that require the contract holder to buy or sell a bond at a predetermined price at a given time. A bond futures contract is traded on a stock futures market and bought or sold through a brokerage firm that offers futures contracts. The conditions (price and expiry date) of the contract will be determined at the time of purchase or sale of the future. The analysis presented here has shown that individual futures and cash securities occupy certain positions in the liquidity hierarchy of US government bonds and react differently to the liquidity environment. Figure 5 breaks down the results of trading hours by instrument. In almost all cases, futures account for a greater share of risk transfer outside of trading hours in the U.S. than during trading hours in the U.S., but the reverse is true for spot securities. The bond futures contract is used for hedging, speculation or arbitrage purposes. Hedging is a form of investment in products that protect inventory. Speculating means investing in products that present a high risk and a high return profile. Arbitrage can occur when there is a price imbalance and traders try to make a profit by buying and selling an asset or security at the same time.
Buying and selling futures contracts is both more efficient and riskier than buying and selling the underlying securities because they are leveraged. To buy $100,000 worth of treasury bills, you need to have something close to that amount, depending on the price. But to buy a Treasury futures contract with a face value of $100,000 from Treasury bills, you just need to deposit $2,025 into a margin account and keep at least $1,500 in the account, as changes in the value of the contract are added to or deducted from it. Investment practitioners who consistently evaluate the relative values of various securities in relation to their liquidity will benefit from the understanding of the liquidity hierarchy presented in this article, whether they are attracted to the 10-year super liquid cash futures contract when immediacy has a premium, given less liquid bonds and contracts when value is higher, or by dividing large futures transactions into smaller units. A trader decides to buy a five-year Treasury bond futures contract with a face value of $100,000, which means that the $100,000 will be paid when it expires. The investor buys on margin and deposits $10,000 into a brokerage account to facilitate trading. ↵14 calendar spreads of futures contracts omitted in this study have higher average trading sizes than pure futures transactions. But the average calendar spread is still significantly smaller than the average spot trade. Figure 1 shows the liquidity hierarchy of futures and treasury instruments, i.e. the average volume DV01 in % for each of the sub-funds described in the previous section.
Futures volumes are represented by grey bars, by OTR bonds by grey bars with black borders and by other securities present by black bars. Although not shown in the figure, the standard deviations of these percentages are quite small. Figure 2 shows that the rankings of most of the instruments in this study are statistically significant, in that the 95% confidence intervals of the DV01 volume do not overlap for the most part. Six buckets of futures. The six sub-funds correspond to the following contracts, all listed on the Chicago Board of Trade: T-note 2 years, T-note 5 years, T-note 10 years, T-note Ultra 10 years, T-Bond or T-Bond 30 years, and Ultra-T-Bond or Ultra 30-year T-Bond. Traders run the risk of a margin call if the losses of futures contracts exceed the funds deposited with a broker. A futures contract is an agreement between two parties. One party agrees to buy and the other party agrees to sell an underlying asset at a predetermined price at a specific time in the future.
On the settlement date of the futures contract, the seller is required to deliver the asset to the buyer. The underlying of a futures contract can be a commodity or a financial instrument such as a bond. A bond futures contract can be held to maturity, and they can also be closed before the maturity date. If the party that built the position closes before maturity, the closing transaction will result in a gain or loss of the position, depending on the value of the futures contract at that time. Risk equivalents are obviously useful for comparing trading a nominal amount of bonds to trading a number of futures contracts. But even when comparing the transactions of two different bonds or two different contracts, risk equivalents are desirable. .
