TABLE OF CONTENTS A widely used risk management instrument in the debt capital markets is the government bond futures contract. This is 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, 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.
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 OTC ones, when traded on an exchange, so they are also referred to as exchange traded futures. In the UK financial futures are traded on LIFFE, the London International Financial Futures Exchange which opened in 1982. LIFFE is the biggest financial futures exchange in Europe in terms of volume of contracts traded. There are four classes of contract traded on LIFFE: short-term interest rate contracts, long-term interest rate contracts (bond futures), currency contracts and stock index contracts.
We discussed short-term interest rate futures contracts, which generally trade as part of the money markets, in Chapter 4. In this section we will look at bond futures contracts, which are an important part of the bond markets; they are used for hedging and...
