Chapter 14

Note and Bond Futures

Futures contracts on government bonds are liquid and require relatively little capital to establish sizable positions. Consequently, these contracts are often the instruments of choice for hedging longer-term interest rate risk and for speculating on the direction of these rates.1

With the theoretical preliminaries of futures contracts and the differences between futures and forward contracts established in Chapter 13, this chapter focuses on the mechanics of U.S. Treasury futures and, in particular, on how the options embedded in these contracts affect valuation and risk. The chapter concludes with a case study that critiques a once-popular trade of a futures contract against an underlying Treasury note.

Futures contracts that trade in Europe and Japan embed only one of the options present in U.S. futures contracts. Therefore, while focused on U.S. Treasury futures, the treatment of this chapter can easily be applied to these international markets.


This section and the next describe the workings of U.S. note and bond futures contracts. The motivations behind the design of these contracts are explained later in this chapter.

Futures contracts on U.S. government bonds do not have one underlying security. Instead, there is a basket of underlying securities defined by some set of rules. The 10-year note contract expiring in September, 2010, for example, with the ticker TYU0, includes as an underlying security any U.S. Treasury note that ...

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