May 2006
Intermediate to advanced
256 pages
4h 46m
English
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Chapter2
THE GOVERNMENT BOND BASIS
Basis trading, also known as cash and carry trading, refers to the activity of simultaneously trading cash bonds and the related bond futures contract. The basis is the difference between the price of a cash market asset (in this book we consider only bonds as the underlying asset) and its price as implied in the futures markets. An open repo market is essential for the smooth operation of basis trading. Most futures exchanges offer at least one bond futures contract. Major exchanges such as the Chicago Board of Trade (CBOT) offer contracts along the entire yield curve; others such as the London International Financial Futures Exchange (LIFFE) provide a market in contracts on bonds denominated in a range of major currencies.
So, the basis of a futures contract is the difference between the spot price of an asset and its price for future delivery as implied by the price of a futures contract written on the asset. Futures contracts are exchange-traded standardised instruments, so they are a form of what is termed a forward instrument, a contract that describes the forward delivery of an asset at a price agreed today. The pricing of forwards and futures follows similar principles but, as we shall see, contains significant detail differences between the two. The simultaneous trading of futures contracts written on government bonds and the bonds themselves is an important part of the government repo markets; in this, and the two subsequent chapters ...
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