Bond Futures


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Bond Future Definition and Valuation Practical Guide

A bond future is a future contract in which the asset for delivery is a government bond.

1. Bond Future Introduction

Any government bonds that meet the maturity specification of a future contract are eligible for delivery. All eligible delivery bonds construct the delivery basket where each bond has its own conversion factor. Conversion factors are used to equalise the coupon and accrued interest differences of all the deliverable bonds. The seller usually picks up the cheapest bond in the basket to deliver, called the cheapest-to-deliver (CTD). The CTD bond is normally delivered on the last delivery day of the month.

Bond futures are exchange-traded with maturities of 2, 5, 10, 30 years, where the typical underlings are treasury notes or bonds. There are established global markets for bond futures. Bond futures provide a liquid alternative for managing interest rate risk. Investors use bond futures to hedge an existing bond portfolio against adverse interest rate movements or enhance the long-term performance of the portfolio. Arbitrageurs profit from the price difference between the spot bonds and the bond futures. Speculators use bond futures in the hope of making a profit on short-term movements in prices. This presentation provides an overview of bond future product and valuation.

2. Bond Future Valuation

The present value of a bond future contract is given by

Bond futures valuation in FinPricing

Practical Notes

  • The key for pricing a bond future is to compute the forward bond price.
  • The forward clean bond price is equal to the forward price of the underlying bond price at today t plus some coupon and accrual interest adjustment.
  •  is the forward price of the bond price P at t.
  •  is the forward price of all coupons between t and T. Those coupons should be excluded from the forward bond price at T.
  • A is the accrual interest before
  • Bond clean price = bond dirty price – accrual interest
  • Github bond futures
3. More Details

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5. Related Topics
5.1. Fixed Rate Bond

A fixed rate bond pays coupons at a fixed rate over the bond life. An investor who wants to earn a guaranteed interest rate for a specified term can choose fixed rate bonds. Due to the fixed coupon, the market value of a fixed rate bond is susceptible to fluctuation in interest rate and therefore has a significant interest rate risk.

The present value of a fixed rate bond can be expressed as

Fixed rate bond valuation in FinPricing

You can find more details at Bond Valuation