Treasury Bond and Treasury Note
Because they are useful in a variety of ways to manage risk, futures contracts on U.S. Treasury securities have been immensely successful. For example, during the first 9 months of 2001, the U.S. Treasury bond (T-bond) contract at the CBOT was one of the most actively traded futures contracts in the world, with over 43 million contracts exchanging hands. The five-year and 10-year U.S. Treasury note (T-note) contracts also have been very successful. In fact, since the fall of 1999, open interest in the CBOT's 10-year T-note futures contract has usually surpassed that for its longterm T-bond contract.1
Note that while most of the material in this chapter describes the T-bond futures contract, the T-note futures contracts are similar to the T-bond contract. Thus, the T-bond pricing principles and hedging examples are directly applicable to the T-note contracts.
The T-bond futures contract prices a hypothetical Treasury bond with 20 years to maturity and a 6% coupon. The 6% coupon began with the March 2000 contract. For contracts that expired before March 2000, the assumed coupon was 8%. The hypothetical bond rarely, if ever, exists. Figure 9.1 presents spot price data of Treasury notes and bonds,2 their bid and asked prices, and their yields to maturity. As shown in Figure 9.1, there are few 6% coupon Treasury bonds that have been issued, but none of them matures in 20 years (i.e., in 2020).
The Chicago Board of Trade futures contract permits the delivery of any U.S. Treasury bonds that, if callable, are not callable for at least 15 years from the first day of the delivery month or, if not callable, have a maturity of at least 15 years from the first day of the delivery month. The seller of the futures contract has the option of choosing which bond to deliver. Hemler (1990) examines this “quality option”3 for the short. However, the seller cannot deliver a variety of bonds; all the bonds delivered must have the same coupon and maturity date. The asset underlying the T-bond futures contract is $100,000 worth of Treasury bonds, in terms of their face value. Thus, if each T-bond delivered has a $1000 face value, then 100 bonds, all with the same coupon and maturity date, must be delivered.
Any T-note with 61/2 to 10 years to maturity or first call (whichever comes first) is deliverable into the 10-year T-note futures contract. The five-year T-note futures contract allows delivery of $100,000 face value of T-notes that had a maturity when they were issued of 51/4 years or less, but must have a maturity of more than 41/4 years as of the first day of the delivery month.4 Finally, the two-year T-note futures contract calls for the delivery of $200,000 face value of T-notes that had an original maturity of 51/4 years or less and still have a maturity longer than 13/4 years on the first