Understanding Treasury Futures

INTEREST RATES
Understanding Treasury Futures

JANUARY 15, 2013

John W. Labuszewski Michael Kamradt David Gibbs
Managing Director Executive Director Director
Research & Product Development
312-466-7469
jlab@cmegroup.com
Interest Rate Products
312-466-7473
michael.kamradt@cmegroup.com
Product Marketing
312-207-2591
david.gibbs@cmegroup.com

1 | Understanding Treasury Futures | January 15, 2013 | CME GROUP
Thirty-year Treasury bond futures were originally
introduced on the Chicago Board of Trade in 1977.
The product line was augmented over the years by
the introduction of 10-year !-year "-year Treasury
note and #0-year $%ltra& Treasury bond futures.
1

This product line has e'perienced tremendous
success as the scale and global significance of %.(.
Treasury investment has grown over the years.
Today these products are utili)ed on an
international basis by institutional and individual
investors for purposes of both abating and assuming
ris* e'posures.

This document is intended to provide an overview of
the fundamentals of trading %.(. Treasury bond and
note futures. +e assume only a cursory *nowledge
of coupon-bearing Treasury securities. Thus we
begin with a primer on the operation of cash
Treasury mar*ets before moving on to provide some
detail regarding the features of the %.(. Treasury
futures contracts as well as a discussion of ris*
management applications with %.(. Treasury
futures.

Coupon-Bearing Treasury Securities

%.(. Treasury bonds and notes represent a loan to
the %.(. government. Bondholders are creditors
rather than e,uity- or share-holders. The %.(.
government agrees to repay the face or principal or
par amount of the security at maturity plus coupon
interest at semi-annual intervals.
"
Treasury
securities are often considered $ris*less&

1
These contracts were originally introduced on the
Chicago Board of Trade -CB.T/. CB.T was merged with
Chicago 0ercantile 1'change -C01/ in 2uly "007 and
now operates as a unit under the C01 3roup 4olding
company umbrella.
"
5nflation 5nde'ed Treasury (ecurities -T56(/ were
introduced in 1997. These securities are offered with
maturities of #0 years7 10 years7 and five years. They
are sold with a stated coupon but promise the return of
the original principal ad8usted to reflect inflation as
measured by the Consumer 6rice 5nde' -C65/ over the
period until maturity. Thus their coupons are typically
established at levels that reflect the premium of long- or
intermediate-term interest rates relative to inflation.
These securities offer investment appeal to those
concerned about the long-term prospects for inflation.
investments given that the $full faith and credit& of
the %.(. government bac*s these securities.
#

The security buyer can either hold the bond or note
until maturity at which time the face value becomes
due7 or the bond or note may be sold in the
secondary mar*ets prior to maturity. 5n the latter
case the investor recovers the mar*et value of the
bond or note which may be more or less than its
face value depending upon prevailing yields. 5n the
meantime the investor receives semi-annual coupon
payments every si' months.

E.g., you purchase 91 million face value of the #-
!:;< note maturing in =ebruary "0"1. This security
pays half its stated coupon or 1-1#:1>< of par on
each si'-month anniversary of its issue. Thus you
receive 9#>"!0 -? #-!:;< of 91 million/ annually
paid out in semi-annual installments of 91;1"! in
=ebruary and @ugust. %pon maturity in =ebruary
"0"1 the 91 million face value is re-paid and the
note e'pires.

Price/Yield Relationship

@ *ey factor governing the performance of bonds in
the mar*et is the relationship of yield and price
movement. 5n general as yields increase bond
prices will decline7 as yields decline prices rise. 5n a
rising rate environment bondholders will witness
their principal value erode7 in a decline rate

#
This characteri)ation is called in ,uestion noting
(tandard A 6oorBs downgrade of long-term %.(.
sovereign debt from @@@ to @@C status in @ugust "011.
0
!00000
1000000
1!00000
"000000
"!00000
#000000
"
0
0
0
"
0
0
1
"
0
0
"
"
0
0
#
"
0
0
D
"
0
0
!
"
0
0
>
"
0
0
7
"
0
0
;
"
0
0
9
"
0
1
0
"
0
1
1
"
0
1
"
Treasury Futures Avg Daily Volue
%ltra #0-Eear 10-Eear !-Eear "-Eear

environment the mar*et value of their bonds will
increase.

!F Yields Rise T"#$ Prices Fall

!F Yields Fall T"#$ Prices Rise

This inverse relationship may be understood when
one loo*s at the mar*etplace as a true auction.
@ssume an investor purchases a 10-year note with a
>< coupon when yields are at ><. Thus the
investor pays 100< of the face or par value of the
security. (ubse,uently rates rise to 7<. The
investor decides to sell the original bond with the
>< yield but no one will pay par as notes are now
,uoted at 7<. Fow he must sell the bond at a
discount to par in order to move the bond. I.e.,
rising rates are accompanied by declining prices.

=alling rates produce the reverse situation. 5f rates
fall to !< our investment yields more than mar*et
rates. Fow the seller can offer it at a premium to
par. Thus declining rates are accompanied by rising
prices. (hould you hold the note until maturity you
would receive the par or face value. 5n the
meantime of course one receives semi-annual
coupon payments.

%uotation Practices

%nli*e money mar*et instruments -including bills
and 1urodollars/ that are ,uoted on a yield basis in
the cash mar*et7 coupon-bearing securities are
fre,uently ,uoted in percent of par to the nearest
1:#"
nd
of 1< of par.

E.g., one may ,uote a bond or note at 97-1;. This
e,uates to a value of 97< of par plus 1;:#"nds.
The decimal e,uivalent of this value is 97.!>"!.
Thus a one million-dollar face value security might
be priced at 997!>"!. 5f the price moves by 1:#"
nd

from 97-1; to 97-19 this e,uates to a movement of
9#1".!0 -per million-dollar face value/.

But often these securities particularly those of
shorter maturities are ,uoted in finer increments
than 1:#"
nd
. =or e'ample one may ,uote the
security to the nearest 1:>D
th
. 5f the value of our
bond or note in the e'ample above were to rally
from 97-1;:#"nds by 1:>D
th
it may be ,uoted at
97-1;C. The trailing $C& may be read as C1:>D
th
.

.r you may ,uote to the nearest 1:1";
th
. 5f our
bond were to rally from 97-1;:#"
nds
by 1:1";
th
it
might be ,uoted on a cash screen as 97-1;". The
trailing $"& may be read as C":;
ths
of 1:#"
nd
7 or
1:1";
th
. 5f the security rallies from 97-1;:#"
nds
by
#:1";
ths
it may be ,uoted as 97-1;>. The trailing
$>& may be read as C>:;
ths
of 1:#"
nd
or #:1";
ths
.

(ometimes ,uotation systems use an alternate
fractional reference. E.g., the value of 97-1;" might
be displayed as 97-1;G. .r a value of 97-1;C
might be displayed as 97-1;H. @ value of 97-1;>
might be displayed as 97-1;I.

=utures ,uotation practices are similar but not
entirely identical. @ ,uote of 97-1;" is the same no
matter whether you are loo*ing at a cash or a
futures ,uote. 5t means 97< of par plus 1;:#"nds
plus 1:1";
th
.

%uotation Practices

Cash Price &eans
Decial
#'uivalent
() o* Par+
Futures
%uote
97-1; 97-1;:#"
nds
97.!>"!000 97-1;
97-1;" or
97-1;G
97-1;:#"
nds

C 1:1";
th

97.!70#1"! 97-1;"
97-1;C or
97-1;H
97-1;:#"
nds

C 1:>D
th

97.!7;1"!0 97-1;!
97-1;> or
97-1;I
97-1;:#"
nds

C #:1";
ths

97.!;!9#7! 97-1;7

But in the case of the cash mar*ets that trailing $"&
means ":;ths of 1:#"
nd
? 1:1";
th
. 5n the case of
the futures mar*ets that trailing $"& represents the
truncated value of 0."! ' 1:#"
nd
or 1:1";
th
. @ ,uote
of 97-1;C in the cash mar*ets is e,uivalent to 97-
1;! in the futures mar*et. That trailing $!&
represents 0.! ' 1:#"
nd
or 1:>D
th
. @ ,uote of 97-
1;> in the cash mar*ets is e,uivalent to 97-1;7 in
the futures mar*et. The trailing $7& represents the
truncated value of 0.7! ' 1:#"
nd
? #:1";
ths
.

The normal commercial $round-lot& in the cash
mar*ets is 91 million face value. @nything less
might be considered an $odd-lot.& 4owever you can
purchase Treasuries in units as small as 91000 face
value. .f course a dealerBs inclination to ,uote
competitive prices may dissipate as si)e diminishes.
#0-year Treasury bond 10-year Treasury note and
!-year Treasury note futures however are traded in
units of 9100000 face value. #-year and "-year

Treasury note futures are traded in units of
9"00000 face value.

Accrued !nterest and Settleent Practices

5n addition to paying the -negotiated/ price of the
coupon-bearing security the buyer also typically
compensates the seller for any interest accrued
between the last semi-annual coupon payment date
and the settlement date of the security.

E.g., it is 2anuary 10 "01#. Eou purchase 91 million
face value of the 1-!:;< Treasury security maturing
in Fovember "0"" -a ten-year note/ for a price of
97-1;C -997!7;1."!/ to yield 1.;9D< for
settlement on the ne't day 2anuary 11 "01#.

5n addition to the price of the security you must
further compensate the seller for interest of
9"!!;.70 accrued during the !7 days between the
original issue date of Fovember 1! "01" and the
settlement date of 2anuary 11 "01#.

This interest is calculated relative to the !7 days
between issue date of Fovember 1! "01" and the
ne't coupon payment date of 0ay 1! "01# or
9"!!;.70 J? -!7:1;1/ ' -91>"!0:"/K. The total
purchase price is 997;##9.9!.

Price o* $ote 997!7;1."!
Accrued !nterest 9"!!;.70
Total 997;##9.9!

Typically securities are transferred through the =ed
wire system from the ban* account of the seller to
that of the buyer vs. cash payment. That
transaction is concluded on the settlement date
which may be different from the transaction date.

%nli*e the futures mar*et where trades are settled
on the same day they are transacted it is customary
to settle a cash transaction on the business day
subse,uent to the actual transaction. Thus if you
purchase the security on a Thursday you typically
settle it on =riday. 5f purchased on a =riday
settlement will generally be concluded on the
following 0onday.

(ometimes however a $s*ip date& settlement is
specified. E.g. one may purchase a security on
0onday for s*ip date settlement on +ednesday. .r
$s*ip-s*ip date& settlement on Thursday7 $s*ip-s*ip-
s*ip date& settlement on the =riday etc. (*ip or
forward date settlements may be useful in order to
match Treasury transaction payments with oneBs
anticipated future cash flows at current mar*et
prices. Theoretically there is no effective limitation
on the number of days over which one may defer
settlement. Thus these cash securities may
effectively be traded as forward contracts.

Treasury Auction Cycle

Treasury securities are auctioned on a regular basis
by the %.(. Treasury which accepts bids on a yield
basis from security dealers. @ certain amount of
each auction is set aside to be placed on a non-
competitive basis at the average yield filled.

6rior to the actual issuance of specific Treasuries
they may be bought or sold on a $+5& or $+hen
5ssued& basis. +hen traded on a +5 basis bids and
offers are ,uoted as a yield rather than as a price.

,-S- Treasury Auction Schedule

&aturity Auctioned
Cash &gt
Bills
%sually 1-7
Lays
@s Feeded
Treasury Bills
D- 1#- and
">-+ee*
+ee*ly
Treasury Bills !"-+ee* 0onthly
Treasury
$otes
"- #- !- and
7-Eear
0onthly
10-Eear
=ebruary 0ay @ugust A
Fovember with re-openings
in other ; months
Treasury
Bonds
#0-Eear
=ebruary 0ay @ugust A
Fovember with re-openings
in other ; months
Treasury
!n*lation
Protected
Securities
(T!PS+
!-Eear
@pril with re-openings in
@ugust A Lecember
10-Eear
2anuary A 2uly with re-
openings in 0arch 0ay
(eptember and Fovember
#-Eear
=ebruary with re-openings in
2une A .ctober

@fter a security is auctioned and the results
announced the Treasury affi'es a particular coupon
to bonds and notes that is near prevailing yields. @t
that time coupon bearing bonds and notes may be
,uoted on a price rather than a yield basis.
4owever bills continue to be ,uoted and traded on
a yield basis. Trades previously concluded on a yield
basis are settled against a price on the actual issue

date of the security calculated per standard price-
yield formulae.

(ecurity dealers purchase these securities and
subse,uently mar*et them to their customers
including pension funds insurance companies
ban*s corporations and retail investors. The most
recently issued securities of a particular maturity are
referred to as $on-the-run& securities. .n-the-runs
are typically the most li,uid and actively traded of
Treasury securities and therefore are often
referenced as pricing benchmar*s. Mess recently
issued securities are *nown to as $off-the-run&
securities and tend to be less li,uid.

The Treasury currently issues D-wee* 1#-wee* ">-
wee* and !"-wee* bills7 "-year #-year !-year 7-
year and 10-year notes7 and #0-year bonds on a
regular schedule. 5n the past the Treasury had also
issued securities with a D-year and "0-year
maturity. =urther the Treasury may issue very
short term cash management bills along with
Treasury 5nflation 6rotected (ecurities or $T56(.&

The .Run/

5f you were to as* a cash dealer for a ,uotation of
$the run& he would ,uote yields associated with the
on-the-run securities from the current on-the-run
Treasury bills through notes all the way to the #0-
year bond sometimes referred to as the $long-bond&
because it is the longest maturity Treasury available.

%uoting 0the Run1
(As o* 2anuary 345 6437+

Coupon &aturity Price Yield
8-9: Bill 0":07:1# 0.0#><
37-9: Bill 0D:11:1# 0.0!1<
6;-9: Bill 07:11:1# 0.0;><
<6-9: Bill 01:09:1D 0.1"7<
6-Yr $ote 1:;< 1":#1:1D 99-"D 1:D 0."DD<
7-Yr $ote #:;< 01:1!:1> 100-00 0.#7"<
<-Yr $ote #:D< 1":#1:17 99-"! #:D 0.7;;<
=-Yr $ote 1-1:;< 1":#1:19 99-"7C 1."9D<
34-Yr $ote 1-!:;< 11:1!:"" 97-1; #:D 1.;9!<
74-Yr Bond "-#:D< 11:1!:D" 9#-1! #.0;!<

The most recently issued security of any tenor may
be referred to as the $new& security. Thus the
second most recently issued security of a particular
original tenor may be referred to as the $old&
security the third most recently issued security is
the $old-old& security the fourth most recently
issued security is the $old-old-old& security.

@s of 2anuary 11 "01# the most recently issued
10-year note was identified as the 1-!:;< note
maturing in Fovember "0""7 the old note was the 1-
!:;< note of @ugust "0""7 the old-old note was the
1-#:D< of 0ay "0""7 the old-old-old note was the
"< of =ebruary "0"".

Beyond that one is e'pected to identify the security
of interest by coupon and maturity. =or e'ample
the $"s of N"1& refers to the note with a coupon of
"< maturing on Fovember 1! "0"1. @s of
2anuary 10 "01# there were not any $+5& or $when
issued& 10-year notes. +5s typically ,uoted and
traded on a yield basis in anticipation of the
establishment of the coupon subse,uent to the
original auction.

34-Year Treasury $otes
(As o* 2anuary 345 6437+

Coupon &aturity Price Yield
9!
>n-the-Run 1-!:;< 11:1!:"" 97-1; #:D 1.;9!<
>ld $ote 1-!:;< ;:1!:"" 9;-01 #:D 1.;D7<
>ld->ld 1-#:D< !:1!:"" 99-1; #:D 1.79;<
>ld->ld->ld "< ":1!:"" 10"-0D #:D 1.7D#<
"< 11:1!:"1 10"-17 #:D 1.>;;<
"-1:;< ;:1!:"1 10#-"; #:D 1.>#7<
#-1:;< !:1!:"1 11"-0! #:D 1.!>"<
#-!:;< ":1!:"1 11>-0D 1:D 1.!01<
"-!:;< 11:1!:"0 10;-1; 1.D>!<
"-!:;< ;:1!:"0 10;-"" 1.D1D<
#-1:"< !:1!:"0 11!-01C 1.#D1<
#-!:;< ":1!:"0 11!-"!C 1.";;<
1-1:;< 1":#1:19 9;-"7 #:D 1."9!<
1< 11:#0:19 9;-0! #:D 1."77<
#-#:;< 11:1!:19 11D-00 #:D 1."#"<
1-1:D< 10:#1:19 99-#1 #:D 1."!1<
1< #:#0:19 9;-1> 1:D 1."#"<

.ne important provision is whether or not the
security is sub8ect to call. @ $callable& security is
one where the issuer has the option of redeeming
the bond at a stated price usually 100< of par
prior to maturity. 5f a bond is callable it may be
identified by its coupon call and maturity date. I.e.,
the 11-#:D< of Fovember "009-1D is callable
beginning in Fovember "009 and matures in "01D.

6rior to the =ebruary 19;> auction the %.(.
Treasury typically issued #0-year bonds with a "!-
year call feature. That practice was discontinued at
that time however as the Treasury instituted its
$(eparate Trading of Oegistered 5nterest and
6rincipal on (ecurities& or (TO56( program with
respect to all newly issued 10-year notes and #0-
year bonds.
D

The Roll and ?i'uidity

Clearly traders who fre,uently buy and sell are
interested in maintaining positions in the most li,uid
securities possible. @s such they tend to prefer on-
the-run as opposed to off-the-run securities.

5t is intuitive that on-the-runs will offer superior
li,uidity when one considers the $life-cycle& of
Treasury securities. Treasuries are auctioned
largely to bro*er-dealers who subse,uently attempt
to place the securities with their customers. .ften
these securities are purchased by investors who may
hold the security until maturity. @t some point
securities are $put-away& in an investment portfolio
until their maturity. .r they may become the
sub8ects of a strip transaction per the (TO56(
program.

D
The (TO56( program was created to facilitate the trade
of )ero-coupon Treasury securities. 6rior to 19;> a
variety of bro*er dealers including 0errill Mynch and
(alomon Bros. issued )ero-coupon securities
collaterali)ed by Treasuries under acronyms such as
T53eOs and C@T(. =or e'ample if you buy a 10-year
Treasury you can create )ero coupon securities of a
variety of maturities by mar*eting the component cash
flows. By selling a )ero collaterali)ed by a coupon
payment due in five years one creates a five-year )ero7
or one may create a ten-year )ero by selling a )ero
collaterali)ed by the principal payment. They engaged in
this practice because the mar*et valued the components
of the security more dearly than the coupon payments
and principal payment bundled together. Today one
might notice that the yield on a Treasury (TO56 is
usually less than a comparable maturity coupon-bearing
Treasury. Beginning with 10s and #0s issued in =ebruary
19;> the Treasury began assigning separate C%(56
numbers to the principal value and to tranches of coupon
payments associated with these securities. @ C%(56
number is a code uni,ue to each security and is
necessary to wire-transfer and therefore mar*et a
security. Thus the Treasury (TO56( mar*et was
created. @s a result of their long duration these
securities are most popular when rates are declining and
prices rising.
@s these securities find a home supplies may
become scare. @s a result bid:offer spreads may
inflate and the security becomes somewhat illi,uid.
Mi,uidity is a valuable commodity to many. Thus
you may notice that the price of on-the-runs may be
bid up resulting in reduced yields relative to other
similar maturity securities. This tends to be most
noticeable with respect to the #0-year bond.

Traders may be interested in conducting a $roll&
transaction where one sells the old security in favor
of the new security in order to maintain a position
in the on-the-run and most li,uid security. Thus
dealers will ,uote a bid:offer spread in the roll
offering the opportunity to sell the old note:buy the
new note7 or buy the old note:sell the new note in
a single transaction.

The $old note& in our table above was ,uoted at a
yield of 1.;D7< while the $new note& was seen at
1.;9!<. 5n this case the roll is ,uoted at
appro'imately negative ! basis points --0.0D;< ?
1.;D7< - 1.;9!</.

This circumstance runs contrary to our typical
assumption that traders will be willing to forfeit a
small amount of yield for the privilege of holding the
most recently issued and presumably most li,uid
security underscoring the point that li,uidity
normally has some observable value.

But circumstances as of 2anuary 10 "01# were a bit
unusual to the e'tent that the yield associated with
the on-the-run 10-year note was higher than that
associated with the old note. +e suggest that this is
indicative of heavy supplies and the rather steep
shape of the yield curve in the 10-year segment of
the curve.

Repo Financing

Meverage is a familiar concept to futures traders.
2ust as one may margin a futures position and
thereby effectively e'tend oneBs capital the
Treasury mar*ets li*ewise permit traders to utili)e
$repo& financing agreements to leverage Treasury
holdings.

@ repurchase agreement repo or simply O6
represents a facile method by which one may borrow
funds typically on a very short-term basis
collaterali)ed by Treasury securities. 5n a repo

agreement the lender will wire transfer same-day
funds to the borrower7 the borrower wire transfers
the Treasury security to the lender with the
provision that the transactions are reversed at term
with the lender wiring bac* the original principal plus
interest.

The borrower is said to have e'ecuted a repurchase
agreement7 the lender is said to have e'ecuted a
reverse repurchase agreement. 0any ban*s and
security dealers will offer this service once the
customer applies and passes a re,uisite credit
chec*.

The *ey to the transaction however is the safety
provided the lender by virtue of the receipt of the
-highly-mar*etable/ Treasury security. These repo
transactions are typically done on an overnight basis
but may be negotiated for a term of one-wee* two-
wee*s one month. @ third party custodian is
fre,uently used to add an additional layer of safety
between the lender and borrower i.e., a tri-party
repo agreement. .vernight repo rates are typically
,uite low in the vicinity of =ed =unds.

@ny Treasury security may be considered $good& or
$general& collateral. (ometimes when particular
Treasuries are in short supply dealers will announce
that the security is $on special& and offer below-
mar*et financing rates in an effort to attract
borrowers.

Treasury Futures Delivery Practices

+hile some traders refer to original or $classic&
Treasury bond futures as $#0-year bond futures&
that reference is actually ,uite misleading. Treasury
bond futures permit the delivery in satisfaction of a
maturing contract of any %.(. Treasury security
provided it matures within a range of 1! to "! years
from the date of delivery. That delivery window
once e'tended from 1! to #0 years and thus the
characteri)ation of the Treasury bond contract as a
$#0-year bond futures& was apt.

Fote that the %ltra T-bond futures contract calls for
the delivery of any bond that does not mature for a
period of at least "! years from the date of delivery.
(ubse,uent to the development of the %ltra bond
contract the delivery window of the original T-bond
futures contract was amended from 1!-#0 years to
1!-"! years. @s such the %ltra T-bond futures
contract currently is most aptly referred to as the
#0-year bond contract while the original bond
futures contract as amended is referred to as the
$classic& bond futures contract.

5t is li*ewise tempting to refer to %.(. Treasury bond
and note futures as $>< contracts.& This too may
be somewhat misleading. T-bond and T-note
futures are based nominally upon a >< coupon
security.

But in point of fact the contract permits the delivery
of any coupon security again provided that it meets
the maturity specification mentioned above. I.e.,
shorts are not necessarily re,uired to deliver ><
coupon bonds. 5n fact there may be no eligible for
delivery securities that actually carry a coupon of
precisely >< at any given time.

Because of the rather broadly defined delivery
specifications a significant number of securities
ranging widely in terms of coupon and maturity
may be eligible for delivery. This applies with e,ual
effect to "- #- !- and 10-year Treasury note
futures7 as well as the classic and %ltra T-bond
futures contracts.

Table 1 included below provides a complete
description of the contract specifications of C01
3roup Treasury futures products.

Conversion Factor !nvoicing Syste

(ecurities with varying characteristics such as
coupon and maturity will of course be more or less
valued by the investment community. 4igh-coupon
securities for e'ample will naturally command a
greater price than comparable low-coupon
securities.

These differences must be reflected in the futures
contract. 5n particular when a short ma*es delivery
of securities in satisfaction of a maturing futures
contract the long will pay a specified invoice price to
the short.

@s discussed above the futures contract permits the
delivery of a wide range of securities at the
discretion of the short. That invoice value must be
ad8usted to reflect the specific pricing characteristics
of the security that is tendered.

@ccordingly Treasury futures utili)e a Pconversion
factorP invoicing system to reflect the value of the
security that is tendered by reference to the ><
futures contract standard. The $6rincipal 5nvoice
@mount& paid from long to short upon delivery may
be identified as the =utures (ettlement 6rice
multiplied by the Conversion =actor -C=/ multiplied
by 91000.

That 91000 constant reflects the 9100000 face
value futures contract si)e associated with most T-
note and T-bond futures. Fote that the "-year T-
note contract is based on a 9"00000 face value
amount. Thus this constant must be reset at
9"000 for "-year Treasury futures.

Principol In:oicc Pricc
= Futurcs Scttlcmcnt x Con:crsion Foctor (CF) x $1,uuu

@ny interest accrued since the last semi-annual
interest payment date is added to the principal
invoice amount to e,ual the Ptotal invoice amount.P

Iotol In:oicc Amount
= Principol In:oicc Amount
+ AccrucJ Intcrcst

@ conversion factor may be thought of as the price
of the delivered security as if it were yielding ><.
Clearly high-coupon securities will tend to have high
C=s while low-coupon securities will tend to have low
C=s. 5n particular bonds with coupons less than the
>< contract standard will have C=s that are less
than 1.07 bonds with coupons greater than >< have
C=s greater than 1.0.

E.g., the conversion factor for delivery of the #-
#:;< T-note of "019 vs. 0arch "01# 10-year T-note
futures is 0.;>0D. This suggests that a #-#:;<
security is appro'imately valued at ;>< as much as
a >< security. @ssuming a futures price of 1#1-
"#C:#"nds -or 1#1.7#D#7! e'pressed in decimal
format/ the principal invoice amount may be
calculated as follows.

Principol In:oicc Pricc = 1S1.7S4S7S x u.86u4 x $1,uuu
= $11S,S44.26

E.g., the conversion factor for delivery of the 1-
#:D< T-note of "0"" vs. 0arch "01# 10-year T-note
futures is 0.7077. This suggests that a 1-#:D<
security is appro'imately valued at 71< as much as
a >< security. @ssuming a futures price of 1#1-"#C
-1#1.7#!#7!/ the principal invoice amount may be
calculated as follows.

Principol In:oicc Pricc = 1S1.7S4S7S x u.7u77 x $1,uuu
= $9S,228.42

5n order to arrive at the total invoice amount one
must of course further add any accrued interest
since the last semi-annual interest payment date to
the principal invoice amount.

Cheapest-to-Deliver

The intent of the conversion factor invoicing system
is to render e,ually economic the delivery of any
eligible-for-delivery securities. Theoretically the
short who has the option of delivering any eligible
security should be indifferent as to his selection.

4owever the C= system is imperfect in practice as
we find that a particular security will tend to emerge
as Pcheapest-to-deliver& -CTL/ after studying the
relationship between cash security prices and
principal invoice amounts.

E.g., on 2anuary 10 "01# one might have been
able to purchase the #-#:;<-19 at 11D-00I
-911D0"#.DD per 9100000 face value unit/. The 1-
I<-"" was valued at 99-1;I -999!;!.9D per
9100000 face value unit/. Compare these cash
values to the principal invoice amounts as follows.

7-7/@)-3A 3-7/8)-66
Futures Price 1#1-"#C 1#1-"#C
B CF 0.;>0D 0.7077
B C35444 91000 91000
Principal !nvoice 911##DD."> 9#"";.D"
Cash Price -911D0"#.DD/ -999!;!.9D/
Delivery Dain/?oss (C;=A-3@+ (C;57<=-<6+

.ur analysis suggests that a loss of 9>79.1; may be
associated with the delivery of the #-#:;<-19 while
an even larger loss of 9>#!7.!" might be
associated with the delivery of the 1-#:D<-"".
Thus we might conclude that the #-#:;<-19 note is
cheaper or more economic to deliver than the 1-
#:D<-"".

The Basis

Typically we e'pect to find a single security or
perhaps a handful of similar securities will emerge
as CTL. This identification has important
implications for basis traders who arbitrage cash and
futures mar*ets. @ basis trader will see* out
arbitrage opportunities or situations where they
might be able to capitali)e on relatively small pricing
discrepancies between cash securities and Treasury
futures by buying $cheap& and selling $rich& items.

@rbitrageurs will trac* these relationships by
studying the Pbasis.P The basis describes the
relationship between cash and futures prices and
may be defined as the cash price less the Pad8usted
futures priceP or the futures price multiplied by the
conversion factor.

Thus the basis is analogous to the gain or loss that
might be reali)ed upon delivery. %nli*e that gain or
loss however the basis is typically e'pressed in
terms of #"
nds
. E.g. 1-1:D points might be shown
as D0:#"
nds
. 5t is also $inverted& in the sense that
we are comparing cash less ad8usted futures prices -
rather than futures invoice price less cash prices.

Bosis = Cosb Pricc - AJ]ustcJ Futurcs Pricc

AJ]ustcJ Futurcs Pricc
= Futurcs Pricc x Con:crsion Foctor

E.g., a comparison of cash and ad8usted futures
prices provides us with a ,uote for the basis
associated with the #-#:;<-19 and 1-#:D<-""
Treasury securities.

7-7/@)-3A 3-7/8)-66
Cash Price 11D-00I 99-1;I
Futures Price 1#1-"#C 1#1-"#C
B CF 0.;>0D 0.7077
AdEusted Futures -11#-11/ -9#-07"/
Basis (76nds+ 63-=78 647-883

The basis of "1.7#D:#"nds associated with the #-
#:;<-19 corresponds to a loss on delivery of
9>79.1; as shown above. (imilarly the basis of
"0#.DD1:#"nds associated with the 1-#:D<-""
corresponds to a loss on delivery of 9>#!7.!".

@s suggested above and as a general rule the
security with the lowest basis i.e., the largest gain
or smallest loss on delivery may be considered CTL.
Clearly the #-#:;<-19 is cheaper-to-deliver than
the 1-#:D<-"".

Table " included below depicting the basis for all
eligible-for-delivery securities vs. the 0arch "01#
10-year T-note futures contract as of 2anuary 10
"01#. Oeferring to Table " one may confirm that
the #-#:;<-19 e'hibited the lowest basis and
therefore may be considered the CTL security.

Fote however that there are ,uite a few securities
with similar coupons and maturities which are near
CTL. 5n fact the entire universe of eligible-for-
delivery securities features reasonably similar
coupons and maturities.

5t is important to identify the CTL security to the
e'tent that Treasury futures will tend to price or
trac* or correlate most closely with the CTL. This
has interesting implications from the standpoint of a
$basis trader& or a hedger as discussed in more
detail below.

(uffice it to say at this point that basis trading is a
fre,uent practice in the Treasury futures mar*ets.
Certain terminology has been developed to identify
basis positions. .ne may $buy the basis& by buying
cash securities and selling futures. .ne may $sell
the basis& by selling cash securities and buying
futures.

Basis transactions are typically transacted in a ratio
that reflects the conversion factor of the security
involved in the trade.

.Buy the Basis/ =
Buy cash securities
F sell *utures

.Sell the Basis/ =
Sell cash securities
F Guy *utures

E.g., if one were to buy the basis by buying 910
million face value of the #-#:;<-19 note one might
sell ;> 0arch "01# futures by reference to the
conversion factor of 0.;>0D.

E.g., if one were to sell the basis by selling 910
million face value of the 1-#:D<-"" note one might
buy 71 0arch "01# futures by reference to the
conversion factor of 0.7077.

By transacting the basis in a ratio identified by
reference to the C= one may roughly balance the
movement or volatility on both legs of the spread.
This is intuitive to the e'tent that the conversion
factor generally reflects the value of the cash
position relative to that of the futures contract. 5f
the C= reflects relative value then presumably it will
reflect relative volatility or price movement as well.

9hy !s >ne !ssue CTDH

5f the conversion factor invoicing system performed
flawlessly all eligible-for-delivery securities would
have a similar basis and be e,ually economic to
deliver. @s suggested above however a single
security or several similar securities tend to emerge
as CTL.

The C= invoicing system is imperfect because it is
implicitly based on the assumption that - -1/ all
eligible-for-delivery securities have the same yield7
and -"/ that yield is ><. But there are any number
of $cash mar*et biases& that impact upon the yield
of a Treasury security.

=urther mathematical biases in the conversion factor
calculation will tilt the field towards securities of
particular coupons and maturities when yields are
greater than or less than the >< contract standard.
4ence we may further spea* of $conversion factor
biases.&

Cash &ar:et Biases

Cash mar*et bias may be used as a catch-all phrase
for anything that impacts upon the relative yields of
bonds. 6erhaps $supply-demand considerations& is
an e,ually appropriate term. @ *ey concept is that
shorts will elect to deliver securities that are cheaper
relative to other securities.

(ome specific reasons why securities even those
with similar coupons and maturities may carry
somewhat different yields include the shape of the
yield curve reinvestment ris*s li,uidity preferences
ta' considerations etc.

5n an upwardly sloping or $normal& yield curve
environment longer-term securities may carry
somewhat higher yields than comparable shorter-
term securities. 6er an inverted yield curve
shorter-term securities may offer higher yields.
Thus a steep yield curve may bias towards the
delivery of lower-yielding securities of longer
maturities. +hile an inverted yield curve may bias
towards the delivery of shorter maturity securities.

6rior to the subprime mortgage crisis that erupted in
"00; the yield curve has been rather flat out past
1! years. Thus this factor has as an historical
matter had little impact on the delivery of bonds
into the #0-year T-bond contract. 0ore recently
however we see that the yield curve has generally
steepened such that the different between 10- and
#0-year yields has e'panded to greater than 1<.
(till this factor may not be terribly overt as it tends
to be obscured by conversion factor biases as
discussed below.

Mow or generally falling yields may prove
problematic to the security investor to the e'tent
that a significant component of oneBs return is
attributable to reinvestment income. Coupon
payments once received will be reinvested
presumably at prevailing short-term rates. +hen
reinvestment ris*s become noticeable investors will
prefer low-coupon securities generating small
coupons carrying limited reinvestment ris*s over
high-coupon securities. Thus those high-coupon
securities may become CTL.

@s discussed above recently issued or $on-the-run&
securities generally offer enhanced li,uidity relative
to $off-the-run& securities. Conse,uently on-the-
run bond prices may be bid up their yields pushed
down and may therefore be unli*ely candidates to
become CTL. Mi*ewise ta' considerations have the
potential to tilt deliveries towards high coupon as
opposed to low coupon securities.

Conversion Factor Biases

6erhaps more important that these cash mar*et
factors there are observable biases associated with
the mathematics of the conversion factor system or
conversion factor biases.

E.g., it is clear that long duration i.e., low-coupon
long-maturity securities will become CTL when
yields are significantly greater than the >< contract
standard. +hen yields fall below the >< contract
standard these factors will bias towards the delivery
of short-duration i.e., high-coupon short-maturity
securities.


!* yields I ;)
Bias to long duration
(i.e., loJ-coupon5 long-
aturity+ securities

!* yields K ;)
Bias to short duration
(i.e., high-coupon5 short-
aturity+ securities

Luration is e'plained more thoroughly below but
thin* of duration as a measure of ris*. +hen yields
are rising and prices are declining investors will
gravitate towards less ris*y or short-duration
securities. They will want to li,uidate ris*ier long
duration securities creating a delivery bias in favor
of those long duration bonds. I.e., while the
conversion factor is fi'ed the relative price
movement of long vs. short duration securities may
be very different thereby creating delivery biases.

.n the other hand when yields are declining and
prices rising investors will prefer those ris*ier long
duration securities. Thus they may wish to
li,uidate less aggressive short duration securities
creating a delivery bias in favor of those short
duration securities.

@s indicated above the #-#:;<-19 was cheapest-
to-deliver as of 2anuary 10 "01# vs. the 0arch
"01# Ten-year T-note futures contract. This
security by virtue of its relatively high coupon and
short maturity stood out as the security with the
lowest duration of >.1!# years amongst the field of
eligible-for-delivery securities. Because yields of
10-year notes were in the range of 1."< to 1.9<
conversion factor biases severely tilted deliveries
towards short duration securities such as the #-
#:;<-19.

0any analysts who consider Treasury basis
relationships describe the transaction as a form of
arbitrage. @rbitrage in turn is often characteri)ed
as a ris*less or near-ris*less transaction. But
arbitrage transactions are defined by a $ris*less&
nature then Treasury basis trading is certainly not
an arbitrage because of course the basis may
fluctuate to a considerable e'tent.

.ther analysts suggest that arbitrage transactions
are not necessarily ris*less. Oather it may be the
case that the value of the transaction is dictated by
considerations apart from simple price movement.
But if independence from directional price movement
is a defining feature of an arbitrage Treasury basis
transactions li*ewise cannot be considered an
arbitrage per se. =re,uently the most overt factor
that dictates the movement of a basis trade is
simple directional price movement.

Consider the period between .ctober "01" and early
2anuary "01# as depicted in our graphic. Luring
this period the price of the 0arch "01# Ten-year T-
note futures e'perienced a price advance from
appro'imately 1#1< to 1#D< of par. (ubse,uently
the mar*et reversed downwards along a similar
scale.

5n other words prices advanced as yields fell only
to be followed by a period where prices declined on
rising yields. Luring the entirety of this period
prices were well above par while yields were well
below the >< futures contract standard. (till
conversion factor biases were diminished or
99
99
100
100
101
101
10"
>
<
CTD Driven Gy Yields
Mong
Luration
(ecurity
100
(hort
Luration
(ecurity
><
1#1.0
1#1.!
1#".0
1#".!
1##.0
1##.!
1#D.0
1
0
:
1
:
1
"
1
0
:
;
:
1
"
1
0
:
1
!
:
1
"
1
0
:
"
"
:
1
"
1
0
:
"
9
:
1
"
1
1
:
!
:
1
"
1
1
:
1
"
:
1
"
1
1
:
1
9
:
1
"
1
1
:
"
>
:
1
"
1
"
:
#
:
1
"
1
"
:
1
0
:
1
"
1
"
:
1
7
:
1
"
1
"
:
"
D
:
1
"
1
"
:
#
1
:
1
"
1
:
7
:
1
#
&ar-37 34-Yr $ote Futures
Yields
Falling
Yields
Rising

wea*ened as prices declined only to strengthen once
again as the mar*et rallied bac*.

The impact of these wea*ening and subse,uently
strengthening conversion factor biases may be
observed by e'amining the basis for several eligible-
for-delivery securities. @ctually the simple and
graudual convergence of cash and futures prices
may be the feature that is most apparent from an
e'amintion of this graphic.

@s prices advanced and yields fell in late .ctober
into early Fovember notice that the basis for long
duration securities such as the 1-I<-"" was
buoyed upwards to the e'tent that its price rose
faster than futures price which traced a shorter
duration CTL. @gain as yields fall below or further
below the >< futures contract standard long
duration securities tend to become less economic to
deliver.

Yields Rising
aGove ;)
Yields Falling
,nder ;)
(ell long duration basis
i.e., sell long duration
securities A buy futures
Buy long duration basis
i.e., buy long duration
securities A sell futures
Buy short duration basis
i.e., buy short duration
securities A sell futures
(ell short duration basis
i.e., sell short duration
securities A buy futures

@s prices declined and yields rose in Lecember and
into 2anuary the basis for long duration securities
such as the 1-!:;<-"" or the 1-#:D<-"" tended to
decline more sharply than the basis for short
duration securities such as the CTL #-#:;<-19.
This is consistent with our observation above that
as yields rise long duration securities tend to
become more economic to deliver.

=inally note that #-#:;<-19 remained cheapest to
deliver throughout the period in ,uestion during
which time its basis converged rather steadily down
towards )ero.

5t is clear that the performance of the basis is
strongly driven by directional price movement in the
Treasury mar*ets. Thus $buying the basis& or
$selling the basis& may be motivated by e'pectations
regarding rising or falling yields. The *ey is to get a
sense of mar*et direction and then identify the long
or short duration securities whose basis values will
be impacted by any si)able price -or yield/
movement.

!plied Repo Rate

+e often suggest that the security with the lowest
basis is cheapest-to-deliver. But to be perfectly
correct we may point out that the structure of
coupon receipts and reinvestment of such coupon
income plays some -generally small/ part in
establishing a particular security as cheapest-to-
deliver as well. 4ence traders often calculate the
$implied repo rate& -5OO/ associated with eligible for
delivery securities to account for such factors.

The 5OO is calculated as the annuali)ed rate of
return associated with the purchase of a security
sale of futures and delivery of the same in
satisfaction of the maturing futures contract. This
calculation ta*es into account all the cash flows
associated with the security. The assumption that
the basis for any particular security may completely
converge to )ero is implicit in the 5OO calculation.

E.g., if one were to buy the #-#:;<-19 basis by
buying the cash securities selling futures in a ratio
dictated by the conversion factor and ma*ing
delivery or at least witnessing full cash-futures
convergence one would loc*-in a return of 0.1"1<.

E.g., if one were to buy the 1-#:D<-"" basis by
buying cash securities and selling futures in a ratio
indicated by reference to the conversion factor and
ma*ing delivery or at least witnessing full cash-
futures convergence one would loc*-in a rate of
return of -";.D1D<.
0
!0
100
1!0
"00
"!0
#00
1
0
:
1
:
1
"
1
0
:
;
:
1
"
1
0
:
1
!
:
1
"
1
0
:
"
"
:
1
"
1
0
:
"
9
:
1
"
1
1
:
!
:
1
"
1
1
:
1
"
:
1
"
1
1
:
1
9
:
1
"
1
1
:
"
>
:
1
"
1
"
:
#
:
1
"
1
"
:
1
0
:
1
"
1
"
:
1
7
:
1
"
1
"
:
"
D
:
1
"
1
"
:
#
1
:
1
"
1
:
7
:
1
#
&ar-37 34-Yr Basis
1-!:;<-"" Basis 1-#:D<-"" Basis
"-!:;< @ug-"0 Basis #-#:;<-19 Basis
1<-19 Basis
?ong
Duration
Basis
Rising
?ong
Duration
Basis
Falling

Clearly it would be preferable to loc*-in a return of
0.1"1< rather than a return of -";.D1D<. Thus
the #-#:;<-19 is cheaper to deliver relative to the
1-#:D<-"". 5n fact if we scan the 5OOs associated
with all securities eligible to be delivered into the
0arch "01# contract in Table " below we find that
the 5OO of 0.1"1< associated with the #-#:;<-19 is
superior to all other 5OOs.

Thus the #-#:;<-19 Treasury security is associated
with the lowest basis and the highest 5OO as of
2anuary 10 "01#. @s a general rule the security
with the lowest basis will li*ewise e'hibit the highest
implied repo rate. 5t is possible that a security with
the lowest basis may not ,uite have the highest 5OO
because of cash flow considerations. But this
statement is generally true. 5n any event this
observation confirms the CTL status of the #-#:;<-
19 as of 2anuary 10 "01#.

By buying the basis of a Treasury security or buying
cash and selling futures one becomes obligated to
ma*e delivery of the Treasury in satisfaction of the
maturing futures contract.
!
Thus buying the basis
of the cheapest-to-deliver #-#:;<-19 vs. a futures
contract that matures two or three months hence
may be considered analogous to other short-term
investment alternatives.

E.g., we might compare the 5OO ? 0.1"1<
associated with the CTL security to the prevailing
1#-wee* T-bill yield of 0.0!1<7 or to the effective
=ed =unds rate of 0.1>0<7 or to a #-month M5B.O
rate at 0.#00<.

5n this e'ample the 5OO associated with the CTL
security was essentially e,uivalent to other short-
term investment opportunities. @s a general rule
however the 5OO even for the CTL security tends to
run at a level that is a bit inferior to the returns
associated with comparable short-term investment
alternatives. The 5OOs associated with all other non
CTL securities are even lower.

This begs the ,uestion - why would anyone ever
want to buy the basis if the returns do not appear to
be competitiveQ The answer lies in the fact that the

!
.ne may of course opt to offset the short futures
contract prior to the delivery period and effectively
abrogate such obligation.
basis conveys other opportunities apart simply from
the opportunity to use the futures contract as a
delivery conveyance.

Consider any discrepancy with respect to the CTL to
represent a ris* premium of sorts. 5f one buys the
CTL security and sells futures with the intention of
ma*ing delivery the worst case scenario has the
basis converging fully to )ero and the hedger
essentially loc*ing in a return e,ual to the 5OO in
this case 0.1"1<.

But if mar*et conditions should change such that
another security becomes CTL this implies that the
basis may advance or at least fail to completely
converge to )ero. @s a result the trader may reali)e
a rate of return that is in fact greater than the
currently calculated 5OO.

Basis >ptionality

5n other words there is a certain degree of
$optionality& associated with the purchase or sale of
the basis. Buying the basis is analogous to buying
an option which of course implies limited ris*.
Buying the basis implies limited ris* to the e'tent
that even under the worst of circumstances you
ma*e delivery of the security which is effectively
e,uivalent to the possibility that the basis fully
converges to )ero.

But $crossovers& or $switch& may occur such that the
basis converges at a slower rate than otherwise
anticipated or actually advances. @s a result this
short-term investment may generate a return which
is -at least theoretically/ unbounded on the upside.
Mimited ris* accompanied by unbounded upside
potential is reminiscent of the ris*:reward profile of
a long option position thus the analogy between a
long basis position and a long option.

The best one may hope by selling the basis or
selling securities and buying futures with the
possibility of effectively replacing the sold security
by standing long in the delivery process is that the
basis fully converges to )ero. This implies limited
profit potential.

But in the event of significant changes in mar*et
conditions the basis may advance sharply e'posing
the seller of the basis to -theoretically/ unbounded
ris*s. Mimited profit potential accompanied by

unbounded ris* is reminiscent of the ris*:reward
profile of a short option position thus the analogy
between a short basis position and a short option.

@s discussed above the basis even for the CTL
security tends to be in e'cess of cost of carry
considerations. This is manifest in the fact that the
5OO even for the CTL is typically a bit below
prevailing short-term rates. This premium in the
basis essentially reflects the uncertainties associated
with which security may become CTL in the future.

Thus the basis performs much a*in to an option.
Mi*e any other option the basis will be affected by
considerations including term volatility and stri*e
price. The relevant term in this case is the term
remaining until the presumed delivery date vs. the
futures contract. 0ar*et volatility affects the
probability that a crossover may occur. Oather than
spea* of a stri*e or e'ercise price it is more
appropriate to assess the mar*etBs pro'imity to a
$crossover point& or a price:yield at which one might
e'pect an alternate security to become CTL.

Consider the purchase or sale of the CTL basis. The
degree to which this basis performs li*e a call or a
put option is contingent upon the relationship
between mar*et prices and the >< futures contract
standard.

5f yields are below the >< futures contract standard
the CTL basis may be e'pected to advance if prices
decline -rates rise/ towards ><7 or decline if prices
advance -rates fall/. Thus buying the CTL basis
when rates are below >< is a*in to the purchase of
a put option. Conversely the sale of the CTL basis
when rates are less than >< is a*in to the sale of a
put option where the value of transaction is capped
if prices should advance while losses may be
unbounded if prices should decline.

5f yields are above the >< futures contract
standard the CTL basis may be e'pected to
advance if prices rise -rates fall/ towards ><7 or
decline if prices fall -rates rise/. Thus buying the
CTL basis when rates are above >< is a*in to the
purchase of a call option. Conversely the sale of
the CTL basis when rates are above >< is a*in to
the sale of a call option where the value of
transaction is capped if prices should decline while
losses may be unbounded if prices should advance.

=inally if rates are close to the >< futures contract
standard the basis for what is currently CTL may be
dictated by considerations apart from conversion
factor biases.

Thus there may be significant crossovers regardless
of whether rates rise or fall. Buying the CTL basis
under these considerations may be considered a*in
to the purchase of an option straddle -i.e., the
simultaneous purchase of call and put options/.

%nder these circumstances the basis buyer may be
indifferent between advancing or declining prices but
has an interest in seeing prices move significantly in
either direction. (elling the CTL basis when rates
are near the >< contract standard is a*in to selling
a straddle -i.e. the simultaneous sale of both call
and put options/. The basis is sold under these
circumstances because the trader anticipates an
essentially neutral mar*et.

Buy CTD Basis Sell CTD Basis
Yields K ;) Buy 6ut .ption (ell 6ut .ption
Yields L ;) Buy (traddle (ell (traddle
Yields I ;) Buy Call .ption (ell Call .ption

.f course the basis premium over carry should
accrue to the short basis trader under circumstances
of continued price stability. But the short basis
trader is e'posed to the ris* of dramatic price
movements in either direction.

@s of 2anuary 10 "01# the 5OO of the CTL #-#:;<-
19 security at 0.1"1< fell s,uarely within the range
of other short-term investment alternatives. This
suggests negligible optionality i.e., the probability
of a crossover or switch is negligible. This is driven
by the fact that yields are well below the >< futures
contract standard. =urther the duration of the #-
#:;<-19 with its high coupon and short maturity
was the shortest by some margin relative to other
eligible for delivery securities. Thus the mar*et
assessed a negligible probably that this security
would not remain CTL by the time we enter the
0arch "01# delivery period.

&easuring Ris:

$Eou canBt manage what you canBt measure& is an
old saying with universal application. 5n the fi'ed
income mar*ets it is paramount to assess the
volatility of oneBs holdings in order reasonably to

manage them. The particular characteristics of a
coupon-bearing security will clearly impact upon its
volatility.

Two readily identifiable ways to define coupon-
bearing securities is in terms of their maturity and
coupon. Lefining volatility as the price reaction of
the security in response to changes in yield we
might draw conclusions as follows.

?onger &aturity Dreater Volatility
"igher Coupon ?oJer Volatility

@ll else held e,ual the longer the maturity of a fi'ed
income security the greater its price reaction to a
change in yield. This may be understood when one
considers that the implications of yield movements
are felt over longer periods the longer the maturity.

.n the other hand high coupon securities will be
less impacted on a percentage basis by changing
yields than low coupon securities. This may be
understood when one considers that high coupon
securities return a greater portion of oneBs original
investment sooner than low coupon securities. Eour
ris*s are reduced to the e'tent that you hold the
cashR

There are a couple of popular ways to measure the
ris*s associated with coupon-bearing -and money-
mar*et/ instruments including basis point value
-B6S/ and duration.

Basis Point Value (BPV+

B6S represents the absolute price change of a
security given a one basis point -0.01</ change in
yield. These figures may be referenced using any
number of commercially available ,uotation services
or software pac*ages. B6S is normally ,uoted in
dollars based on a 91 million -round-lot/ unit of cash
securities. The following table depicts the B6Ss of
various on-the-run Treasuries as of 2anuary 10
"01#.

E.g., this suggests that if the yield on the #0-year
bond were to rise by a single basis point -0.01</
the price should decline by some 91;!; per 91
million face value unit.

Duration

5f B6S measures the absolute change in the value of
a security given a yield fluctuation7 duration may be
thought of as a measure of relative or percentage
change. The duration -typically ,uoted in years/
measures the e'pected percentage change in the
value of a security given a one-hundred basis point
-1</ change in yield.

Luration is calculated as the average weighted
maturity of all the cash flows associated with the
bond i.e., repayment of $corpus& or face value at
maturity plus coupon payments all discounted to
their present value.

&easuring Volatility
(As o* 2anuary 345 6437+

Coupon
&at-
urity
Dur-
ation
(Yrs+
BPV
(per il+
6-Yr $ote 1:;< 1":#1:1D 1.9>! 919>
7-Yr $ote #:;< 01:1!:1> ".9;0 9"9;
<-Yr $ote #:D< 1":#1:17 D.;>7 9D;>
=-Yr $ote 1-1:;< 1":#1:19 >.>7> 9>>0
34-Yr $ote 1-!:;< 11:1!:"" 9.01> 9;;"
74-Yr Bond "-#:D< 11:1!:D" 19.7;; 91;!;

E.g., the #0-year bond is associated with duration of
19.7;; years. This implies that if its yield advances
by 100 basis points -1.00</ we e'pect a 19.7;;<
decline in the value of the bond.

5n years past it was commonplace to evaluate the
volatility of coupon-bearing securities simply by
reference to maturity. But this is ,uite misleading.
5f one simply e'amines the maturities of the current
"-year note and 10-year note one might conclude
that the 10-year is ! times as volatile as the "-year.

But by e'amining durations we reach a far different
conclusion. The 10-year note -duration of 9.01>
years/ is only about D-H times as volatile as the "-
year note -duration of 1.9>! years/. The availability
of cheap computing power has made duration
analysis as easy as it is illuminating.

Ris: &anageent

Treasury futures are intended to provide ris* averse
fi'ed income investors with the opportunity to hedge

or manage the ris*s inherent in their investment
activities. 1ffective use of these contracts however
re,uires a certain grounding in hedge techni,ues.

0ost pointedly one may attempt to assess the
relative volatility of the cash item to be hedged
relative to the futures contract price. This
relationship is often identified as the futures $4edge
Oatio& -4O/. 4edge ratios reflect the e'pected
relative movement of cash and futures and provide
ris* managers with an indication as to how many
futures to use to offset a cash e'posure.

Face Value 9eighted "edge

The most superficial way to approach identification of
the appropriate hedge ratio is simply to match the
face value of the item to be hedged with the face
value of the futures contract.

E.g., if one owned 910 million face value of a
particular security the natural inclination is to sell or
short one-hundred -100/ 9100000 face value futures
contracts for a total of 910 million face value. Thus
the face value of hedged security matches the face
value held in futures.

+hile this method has the advantage of e'treme
simplicity it ignores the fact that securities of varying
coupons and maturities have different ris*
characteristics.

CF 9eighted "edge

Treasury futures contract specifications conveniently
provide a facile means by which to assess the relative
ris*s associated with cash and futures. @s discussed
above the conversion factor -C=/ represents the price
of a particular bond as if it were to yield ><.
Thus the C= reflects the relative value and by
implication the relative volatility between cash and
futures prices. 0ost basis trades are in fact
concluded in a ratio identified by reference to the C=.

E.g., if one held 910 million face value of the #-
#:;<-19 note one might sell ;> 0arch "01# futures
by reference to the conversion factor of 0.;>0D to
e'ecute a hedge.

E.g., if one held 910 million face value of the 1-
#:D<-"" note one might sell 71 0arch "01# futures
by reference to the conversion factor of 0.7077 to
e'ecute a hedge.

@ conversion factor weighted hedge is li*ely to be
,uite effective if you are hedging the cheapest-to-
deliver security. Treasury futures will tend to price or
trac* or correlate most closely with the CTL security.

But other securities with different coupons and
maturities may react to changing mar*et conditions
differently. Thus one might ,uestion if you can or
should do better than a C= weighted hedgeQ

BPV 9eighted "edge

5n order to understand the most effective techni,ues
with which to apply a hedge consider the
fundamental ob8ective associated with a hedge. @n
$ideal& hedge is intended to balance any loss -profit/
in the cash mar*ets with an e,ual and opposite profit
-loss/ in futures.

.ur goal therefore is to find a hedge ratio -4O/ that
allows one to balance the change in the value of the
cash instrument to be hedged -T
hedge
/ with any
change in the value of the futures contract -T
futures
/.
Fote that we use the 3ree* letter delta or T to denote
the abstract concept of change in value.

A
hcdgc
= ER x A
]utucs

+e solve for the hedge ratio -4O/ as follows.

ER = A
hcdgc
A
]utucs

Because we have not defined what we mean by
$change in value& the e,uation above is of an
abstract nature and cannot be directly applied. Thus
letBs bac*trac* to discuss the relationship between
Treasury futures and cash prices.

6er our discussion above principal invoice amount
paid from long to short upon deliver will be e,ual to
the price of the cash security multiplied by its
conversion factor. Oational shorts will of course
elect to tender the cheapest-to-deliver security.
Thus we might designate the futures price and the
conversion factor of the cheapest-to-deliver as 6
futures

and C=
ctd
respectively.

Principol In:oicc Pricc = P
]utucs
x CF
ctd

Because the basis of the CTL is generally closest to
)ero relative to all other eligible securities we might
assume that the futures price level and by
implication any changes in the futures price level
-T
futures
/ will be a reflection of any changes in the
value of the CTL -T
ctd
/ ad8usted by its conversion
factor -C=
ctd
/ as follows.

A
]utucs
=
A
ctd
CF
ctd

(ubstituting this ,uantity into our e,uation specified
above we arrive at the following formula.

ER = A
hcdgc
_
A
ctd
CF
ctd
]

+e might further rearrange the e,uation as follows.

ER = CF
ctd
x _
A
hcdgc
A
ctd
]

%nfortunately this concept of $change in value&
remains abstract. Met us $operationali)e& the concept
by substituting the basis point value of the hedged
security -B6S
hedge
/ and the basis point value of the
cheapest-to-deliver -B6S
ctd
/ for that abstract concept.

Oecall from our discussion above that a basis point
value represents the e'pected change in the value of
a security e'pressed in dollars per 91 million face
value given a one basis point -0.01</ change in
yield. Thus we identify the basis point value hedge
ratio -or $B6S 4O&/ as follows.

BPI ER = CF
ctd
x _
BPI
hcdgc
BPI
ctd
]

.ur analysis implicitly assumes that any changes in
the yield of the hedged security and that of the
cheapest-to-deliver security will be identical. I.e.,
that we will e'perience $parallel& shifts in the yield
curve. This analysis further presumes that you are
able to identify the cheapest-to-deliver security and
that it will remain cheapest-to-deliver. The latter
assumption is of course ,uestionable in a dynamic
mar*et.

E.g., let us find the basis point value hedge ratio -4O/
re,uired to hedge 910 million face value of the 1-
#:D<-"" note security. This security carried a B6S ?
9;!!0 per 910 million. The CTL security was the #-
#:;<-19 with a B6S ? 970.!0 per 9100000 face
value and a conversion factor of 0.;>0D vs. 0arch
"01# Ten-year T-note futures. The hedge ratio may
be identified as 10D contracts per 910 million face
value of the 1-#:D<-1".

BPI ER = u.86u4 x _
$8,SSu
$7u.Su
_ = 1u4.S or 1u4 controcts

Fote that the 4O ? 10D is significantly greater than
the 71 contracts suggested by reference to the
conversion factor of the 1-#:D<-"" security. This is
due to the fact that the CTL security carries a
relatively short duration of >.1!# years compared to
the duration associated with the hedged security of
;.!;; years.

5t is no coincidence that the ratio of durations is
roughly e,ual to the ratio between the B6S and C=
hedge ratios or ->.1!# U ;.!!;/ V -71 M 10D/. I.e.,
the futures contract is pricing or trac*ing or
correlating most closely with a shorter duration
security. Conse,uently futures prices will react
rather mildly to fluctuating yields. Therefore one
re,uires more futures to enact an effective hedge.

E.g., what would our hedge ratio be if the CTL
security was the on-the-run 1-!:;<-"" with a rather
longer duration of 9.01> yearsQ This security has a
B6S of 9;;."0 per 9100000 face value and a
conversion factor for delivery vs. 0arch "01# Ten-
year T-note futures of 0.>;>7. .ur analysis suggests
that one might hedge with 77 contracts per 910
million face value of the "-!:;<-"0.

BPI ER = u.6867 x _
$8,SSu
$88.2u
_ = 66.6 or 67 controcts

Fote that this hedge ratio of >7 contracts is
significantly less than the 10D contracts suggested by
our analysis above and reasonably similar to the 71
contracts suggested by the C= hedge ratio. This can
be e'plained by the fact that the 1-!:;<-"" has
pricing characteristics that are ,uite similar to 1-
#:D<-"" security which is the sub8ect of the hedge.
5n particular the 1-!:;<-"" had a duration of 9.01>
years which is reasonably close to the ;.!!; duration
of the 1-#:D<-"". Because of the similar ris*
characteristics of the CTL and hedged security the
C= may do a reasonable 8ob of identifying an
appropriate hedge ratio.

Crossover Ris:s

This further suggests that if there is a crossover in
the CTL from a short duration security to a longer
duration security the number of futures needed to
hedge against the ris* of declining prices is
decreased. This may be a favorable circumstance for
the hedger who is long cash Treasuries and short
futures in a ratio prescribed by the B6S techni,ue.

Consider that as prices decline and longer duration
securities become CTL one is essentially over-
hedged in a declining mar*et. 5f on the other hand
prices advance and even shorter duration securities
become CTL the appropriate hedge ratio will tend to
increase. Thus the long hedger becomes under-
hedged in a rising mar*et.

@nother way of saying this is that there is a certain
degree of $conve'ity& inherent in the relationship that
favors the long hedger or long basis trader -long cash
and short futures/. Conversely this conve'ity tends
to wor* to the disadvantage of the short hedger or
short basis trader -short cash and long futures/.

.nce again we may li*en the basis to an option to
the e'tent that option premiums are also affected by
conve'ity. =urther because the long basis trader
effectively owns the option he pays an implicit
premium in the difference between prevailing short-
term yields and the return on the basis trade as
might be simulated in the absence of any CTL
crossovers.

The short basis trader is effectively short an option
and receives this implicit premium. This implicit
premium is reflected in a comparison of the 5mplied
Oate of Oeturn -5OO/ relative to prevailing short-term
rates.

Fote that the B6S of a debt security is dynamic and
sub8ect to change given fluctuating yields. @s a
general rule B6S declines as a function of maturity7
and as yields increase -decrease/ B6Ss decline
-advance/. This implies that the hedge ratio is
li*ewise dynamic. .ver a limited period of time
however 4Os may be reasonably stable provided
there is no crossover in the cheapest-to-deliver. @s a
general rule in practice it would be commonplace for
hedgers to re-valuate and read8ust the hedge if rates
were to move by perhaps "0-"! basis points.

Port*olio "edging

Thus far our discussion has centered about
comparisons between a single security and a
Treasury futures contract a $micro& hedge if you
will. But it is far more commonplace for an investor
to become concerned about the value of a portfolio
of securities rather than focus on a single item
within a presumably diversified set of holdings.

4ow might one address the ris*s associated with a
portfolio of securities i.e. how to e'ecute a $macro&
hedgeQ The same principles apply whether hedging
a single security or a portfolio of securities. Thus
we need to evaluate the ris* characteristics of the
portfolio in terms of its B6S and duration 8ust as we
would e'amine an individual security. Then we may
simply apply the B6S hedge ratio for these purposes.

ER = BPI
pot]oIo
_
BPI
ctd
CF
ctd
]

E.g., assume that you held a 9100 million fi'ed
income portfolio with a B6S ? 9;0000 and a
duration of ; years. This duration is similar to the
duration associated with securities deliverable
against the 10-year T-note futures contract
suggesting use of the 10-year as a hedge vehicle.
@s of 2anuary 10 "01# the CTL security was the #-
#:;<-19 with a B6S ? 970.!0 per 9100000 face
value unit and a C= ? 0.;>0D. .ur analysis
suggests that one might sell 97> futures to hedge
the portfolio.

ER = $8u,uuu _
$7u.Su
u.86u4
_ = 976.S or 976 controcts

Thus far our e'amples illustrated situations where
we had effectively hedged individual securities or
portfolios in their entirety. 5n the process we might
effectively push the ris* e'posure down to near 90
as measured by B6S or 0 years as measured by
duration. But it would actually be uncommon to see
an asset manager ad8ust an actual fi'ed income ris*
e'posure all the way down to )ero.

@sset managers generally measure their
performance by reference to a designated
$benchmar*& or $bogey.& The benchmar* is often
identified as an inde' of fi'ed income securities such
as the Barcap %.(. @ggregate Bond 5nde' or some
other commonly available measure.

The returns on this benchmar* may be identified as
the $core& or $beta& returns associated with the
portfolio. 5n addition the asset manager may
e'ercise some limited degree of latitude in an
attempt to outperform the benchmar* or to capture
some e'cess return *nown as $alpha& in current
investment parlance.

@sset manager may be authori)ed to ad8ust the
duration of the portfolio upwards by a limited
amount in anticipation of rate declines and price
advances. .r to ad8ust duration downwards by a
limited amount in anticipation of rate advances and
price declines. The following formula provides the
appropriate hedge ratio for these operations.

ER = _
tugct
-
cucnt
cucnt
] x _BPI
pot]oIo
_
BPI
ctd
CF
ctd
]_

+here L
target
is the target duration7 L
current
is the
current duration.

E.g., letBs return to our e'ample of a 9100 million
fi'ed income portfolio. @ssume that the portfolio
duration of ; years was designed to coordinate with
the duration of the designated benchmar*. Thus
the portfolio manager may be authori)ed to ad8ust
portfolio duration between > and 10 years in pursuit
of $alpha.& The asset manager is now concerned
about the prospects for rate advances and wishes
downwardly to ad8ust duration from ; to > years.
.ur analysis suggests that this may be accomplished
by selling ">" futures.

ER = _
6 - 8
8
] x _$8u,uuu _
$7u.Su
u.86u4
__
= -244.1 or scll 244 controcts

The application of this formula provides asset
managers with a great deal of fle'ibility to ad8ust
the portfolio duration W either upward or downward
W to meet the demands of the moment.

Bullets and BarGells

Typically one loo*s to hedge a Treasury portfolio
with the use of Treasury futures which correspond
most closely in terms of duration to the average
weighted portfolio duration.

E.g., if one held a portfolio with an average
weighted duration of D years it would be natural to
loo* to !-year Treasury note futures as a suitable
ris* layoff vehicle. 5f the portfolio had an average
weighted duration of ; years it would be natural to
loo* to 10-year Treasury note futures.

This analysis would tend to wor* well when the
portfolio is constructed predominantly of securities
which were close in terms of their durations to the
average portfolio duration. Certainly if the entire
portfolio were populated with a variety of recently
issued !-year T-notes it would behoove the hedger
to utili)e !-year Treasury note futures as a hedge
minimi)ing basis ris* and the need for any
subse,uent hedge management.

@ portfolio constructed in such a manner might be
labeled a $bullet& portfolio to the e'tent that it
contains reasonably homogeneous securities in
terms of maturity and presumably coupon. %nder
these circumstances one might simply $stac*& the
entire hedge in a single Treasury futures contract
which most closely conforms to the duration of the
portfolio constituents.

.f course one may attempt to introduce a certain
speculative element into the hedge by using longer-
or shorter-term futures contracts as the focus of the
hedge.
5f the yield curve were e'pected to steepen a hedge
using longer-term futures e.g., 10- or #0-year
Treasury futures rather than !-year futures would
allow one to capitali)e on movement in the curve
beyond simply immuni)ing the portfolio from ris*.
5f the yield curve is e'pected to flatten or invert a
hedge using shorter-term futures e.g., "-year or #-
-"!.00
-"0.00
-1!.00
-10.00
-!.00
0.00
!.00
10.00
1!.00
"0.00
"!.00
;
0
;
1
;
"
;
#
;
D
;
!
;
>
;
7
;
;
;
9
9
0
9
1
9
"
9
#
9
D
9
!
9
>
9
7
9
;
9
9
1
0
0
1
0
1
1
0
"
1
0
#
1
0
D
1
0
!
1
0
>
1
0
7
1
0
;
1
0
9
1
1
0
1
1
1
1
1
"
1
1
#
1
1
D
1
1
!
1
1
>
1
1
7
1
1
;
1
1
9
1
"
0
O
e
t
u
r
n
0ar*et 6rices
"edged Jith Short Futures
=i'ed 5ncome 6ortfolio =ully 4edged
6artially 4edged
6rices Lecline A
Eields @dvance
6rices @dvance A
Eields Lecline

year Treasury futures rather than !-year futures
could li*ewise provide yield enhancement.

But a portfolio need not necessarily be constructed
per the $bullet& approach. Consider a portfolio with
a duration of D years that is constructed using a
combination of "- and 10-year notes and no !-year
notes whatsoever.

@ portfolio constructed in such a manner may be
labeled a $barbell& portfolio to the e'tent that it is
$weighted& with two e'treme duration securities with
no intermediate duration securities at all. 5f one
were to simply stac* the hedge into !-year Treasury
note futures the investor becomes e'posed to the
ris* that the shape of the yield curve becomes
distorted such that !-year yields sag below yields in
the "- and 10-year sectors of the curve.

The holder of a barbell portfolio might instead
attempt to utili)e a combination of various tenured
Treasury futures which is weighted with an eye to
the proportion of the portfolio devoted to each
sector of the yield curve. @s such the hedger may
insulate from the ris*s that the shape of the yield
curve will shift.

Thus an asset manager might categori)e his
holdings into various sectors of the curve
corresponding to available Treasury futures
$buc*ets& i.e., "- !- 10- and #0-year securities.
Then the asset manager may calculate the B6S 4Os
applicable to each of those buc*eted portfolios and
essentially hedge each element separately.

5f however the investor wished to introduce a
speculative element into the hedge the use of
longer- or shorter-maturity Treasuries driven by an
e'pectation of a steepening or flattening yield curve
respectively may be in order.


TaGle 3N Treasury Contracts Suary

6-Year T-
$ote Futures
7-Year T-
$ote Futures
<-Year T-
$ote Futures
34-Year T-
$ote Futures
Classic T-
Bond Futures
,ltra T-Bond
Futures
Contract SiOe
9"00000 face-value %.(.
Treasury notes
9100000 face-value %.(.
Treasury notes
9100000 face-value %.(.
Treasury bonds
Delivery Drade
T-notes with
original
maturity of not
more than !
years and #
months and
remaining
maturity of not
less than 1
year and 9
months from
1st day of
delivery month
but not more
than " years
from last day
of delivery
month
T-Fotes with
original
maturity of not
more than !-
1:D years and
a remaining
maturity of not
more than #
years but not
less than "
years 9
months from
last day of
delivery month

T-notes with
original
maturity of not
more than !
years and #
months and
remaining
maturity of not
less than D
years and "
months as of
1st day of
delivery
month.
T-notes
maturing at
least >-H
years but not
more than 10
years from
1st day of
delivery
month.
T-bonds with
remaining
maturity of at
least 1! years
but no more
than "! years.
T-bonds with
remaining
maturity of at
least "! years
but no more
than #0 years
!nvoice Price 5nvoice price ? settlement price ' conversion factor -C=/ C accrued interest C= ? price to yield ><
Delivery
&ethod
Sia =ederal Oeserve boo*-entry wire-transfer
Contract
&onths
0arch ,uarterly cycle W 0arch 2une (eptember Lecember
Trading "ours
.pen @uctionX 7X"0 am-"X00 pm 0onday-=riday7 1lectronicX >X00 pm - DX00 pm (unday-=riday
-Central Times/
?ast Trading F
Delivery Day
Business day preceding last 7 business days of month7 last delivery day is last business day of delivery
month
Price %uote
5n percent of par to one-,uarter
of 1:#"nd of 1< of par -91!.>"!
rounded up to nearest cent/
Yuoted in percent of par to one-
half of 1:#"nd of 1< of par
-91!.>"! rounded up to nearest
cent/
Yuoted in percent of par to
1:#"nd of 1< of par -9#1."!/

TaGle 6N &arch 6437 Ten-Year T-$ote Futures Basis
(As o* 2anuary 345 6437+

Coupon &aturity Price Yield CF Basis !RR Duration
1-!:;< 11:1!:"" 97-1;I 1.;9!< 0.>;>7 ""7.9>> -#".;#;< 9.01>
1-!:;< ;:1!:"" 9;-01I 1.;D7< 0.>9"; "17."!" -#1.09"< ;.77!
1-#:D< !:1!:"" 99-1;I 1.79;< 0.7077 "0#.DD1 -";.D1D< ;.!!;
"< ":1!:"" 10"-0DI 1.7D#< 0.7#07 11;.D;D -"!.#1D< ;."#D
"< 11:1!:"1 10"-17I 1.>;;< 0.7#>7 17>.191 -"#.D"0< ;.0>7
"-1:;< ;:1!:"1 10#-";I 1.>#7< 0.7!07 1>0.17D -"0.7DD< 7.7;9
#-1:;< !:1!:"1 11"-0!I 1.!>"< 0.;19D 1#!.!>9 -1!.0!#< 7.#;"
#-!:;< ":1!:"1 11>-0DG 1.!01< 0.;!DD 1D.!"7 -11.D>9< 7.0#D
"-!:;< 11:1!:"0 10;-1; 1.D>!< 0.79;! 107.9"# -1".">D< 7.09!
"-!:;< ;:1!:"0 10;-"" 1.D1D< 0.;0#9 ;9.1>0 -9.7"7< >.;!#
#-1:"< !:1!:"0 11!-01C 1.#D1< 0.;!;; >1.""9 -D.;"9< >.!#0
#-!:;< ":1!:"0 11!-"!C 1.";;< 0.;>97 #9.";0 -1.9"#< >.">>
1-1:;< 1":#1:19 9;-"7I 1."9!< 0.7#"> 7!.D7! -10.1>!< >.>7>
1< 11:#0:19 9;-0!I 1."77< 0.7#D1 D7.1!1 ->.09!< >.!;!
#-#:;< 11:1!:19 11D-00I 1."#"< 0.;>0D "1.7#D 0.1"1< >.1!#
1-1:D< 10:#1:19 99-#1P 1."!1< 0.7D7D D9.0;! ->.00;< >.D;!
1< #:#0:19 9;-1>G 1."#"< 0.7#D1 !7.>!1 -7.>#7< >.D!#

$>T#S
0arch "01# futures were priced at 1#1-"#C:#"nds
(ecurities highlighted in red represent least economic-to-deliver7
highlighted in green represent most economic-to-deliver.

Copyright 6437 C&# Droup All Rights Reserved- =utures trading is not suitable for all investors and involves the ris* of loss. =utures are a leveraged investment and because only a
percentage of a contractBs value is re,uired to trade it is possible to lose more than the amount of money deposited for a futures position. Therefore traders should only use funds that they
can afford to lose without affecting their lifestyles. @nd only a portion of those funds should be devoted to any one trade because they cannot e'pect to profit on every trade. @ll e'amples in
this brochure are hypothetical situations used for e'planation purposes only and should not be considered investment advice or the results of actual mar*et e'perience.&

(waps trading is not suitable for all investors involves the ris* of loss and should only be underta*en by investors who are 1C6s within the meaning of section 1-a/1; of the Commodity
1'change @ct. (waps are a leveraged investment and because only a percentage of a contractBs value is re,uired to trade it is possible to lose more than the amount of money deposited for
a swaps position. Therefore traders should only use funds that they can afford to lose without affecting their lifestyles. @nd only a portion of those funds should be devoted to any one trade
because they cannot e'pect to profit on every trade.

C01 3roup is a trademar* of C01 3roup 5nc. The 3lobe logo 1-mini 3lobe' C01 and Chicago 0ercantile 1'change are trademar*s of Chicago 0ercantile 1'change 5nc. Chicago Board of
Trade is a trademar* of the Board of Trade of the City of Chicago 5nc. FE01Z is a trademar* of the Few Eor* 0ercantile 1'change 5nc.

The information within this document has been compiled by C01 3roup for general purposes only and has not ta*en into account the specific situations of any recipients of the information.
C01 3roup assumes no responsibility for any errors or omissions. @dditionally all e'amples contained herein are hypothetical situations used for e'planation purposes only and should not
be considered investment advice or the results of actual mar*et e'perience. @ll matters pertaining to rules and specifications herein are made sub8ect to and are superseded by official C01
FE01Z and CB.T rules. Current C01:CB.T:FE01Z rules should be consulted in all cases before ta*ing any action.

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