The most widely used risk management instrument in the bond markets is the government-bond futures contract. This is usually an exchange-traded standardised contract that fixes the price today at which a specified quantity and quality of a bond will be delivered at a date during the expiry month of the futures contract. Unlike short-term interest-rate futures, which only require cash settlement, and which we encountered in the section on money markets, bond futures require the actual physical delivery of a bond when they are settled.
In this chapter we review bond futures contracts and their use for trading and hedging purposes.
The concept of a bond futures contract is probably easier to grasp intuitively than a short-dated interest-rate future. This reflects the fact that a bond futures contract represents an underlying physical asset, the bond itself, and a bond must be delivered on expiry of the contract. In this way, bond futures are similar to commodity futures, which also require physical delivery of the underlying commodity.
A futures contract is an agreement between two counterparties that fixes the terms of an exchange that will take place between them at some future date. They are standardised agreements, as opposed to over-the-counter (OTC) ones, when traded on an exchange, so they are also referred to as exchange-traded futures. In the United Kingdom, financial futures are traded on London International Financial ...