By Moorad Choudhry
The 2d version of The Futures Bond foundation, is an up to date and revised model of Professor Moorad Choudhry's succinct yet in-depth examine the govt. bond futures agreement foundation. It contains crucial heritage on agreement standards and the speculation of the root. It additionally covers the idea that of the most cost effective to convey; rate and supply information for a pattern of gilt contracts; the drivers of the foundation and its dynamics; the mechanics of foundation buying and selling; a close clarification of gross and internet foundation, and a proof of the implied repo cost. The e-book makes use of examples from the united kingdom gilt marketplace, even if the elemental ideas are acceptable in any bond futures marketplace.
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Additional info for The Futures Bond Basis
It is in circumstances of 20 THE FUTURES BOND BASIS changes in the shape of the yield curve that opportunities for relative value and arbitrage trading arise, especially as the bond that is cheapest-to-deliver for the futures contract may change with large changes in the curve. A trading strategy that involved simultaneous and opposite positions in the cheapest-to-deliver (CTD) bond and the futures contract is what we have termed cash-and-carry trading or basis trading. However, by the law of no-arbitrage pricing, the payoff from such a trading strategy should be 0.
The hedging requirement can arise for different reasons. A market maker will wish to hedge positions arising out of client business, when they are unsure when the resulting bond positions will be unwound. A fund manager may, for example, know that they need to realise a cash sum at a specific time in the future to meet fund liabilities, and sell bonds at that time. The market maker will want to hedge against a drop in value of positions during the time the bonds are held. The fund manager will want to hedge against a rise in interest rates between now and the bond sale date, to protect the value of the portfolio.
The interest rate for borrowing or lending funds, from the trade date to the maturity date of the futures contract. This is known as the repo rate. For the purpose of deriving this pricing model we can ignore bid–offer spreads and borrowing and lending spreads. We set the following: r rc Pbond Pfut t is is is is is the the the the the repo rate; bond’s running yield; price of the cash bond; price of the futures contract; time to the expiry of the futures contract. We can substitute these symbols into the cash flow profile for our earlier trade strategy, that of buying the bond and selling the future.