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Treasury Futures: Why at Such a High Premium?

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Happy to be corrected by someone with good fundamental knowledge. Meantime this is the best I can do for you:

 

You are not quite comparing apples with apples.

On the one hand you are quoting the price of an actual tangible 5-Year bond with 0.625% coupon, effective yield 0.77%, price 99-135 (Bloomberg states the coupon is 0.625).

 

On the other hand you are quoting a 5-Year bond futures contract for which the underlying is a notional 5-Year bond yielding 6%... hence your 123 price being well above 99.

 

Extra detail from CBOT:

"The invoice price equals the futures settlement price times a conversion factor, plus accrued interest. The conversion factor is the price of the delivered note ($1 par value) to yield 6 percent."

 

Extra detail from CBOT:

"The conversion factor represents the price at which $1 face value of the deliverable grade issue, if transacted and settled during the futures contract delivery month, would yield 6 percent."

http://www.cmegroup.com/trading/interest-rates/files/CL-100_TFDPBrochureFINAL.pdf

page 23

 

Just as an aside, Bund futures (FGBL) contract specifications from Eurex states that the underlying notional bond has 100,000EUR value and a coupon of 6%. (Coupon, that time, not yield as per USTY, but seems similar concept)

 

I don't think im a million miles wrong with this answer,

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Thanks Ninja. I think you might have the right answer, but can you elaborate mathematically about the "6% yield." Still a little confused:crap:. For example, I thought market prices for bonds mathematically determine the yield, but here it seems like CBOT set the yield to 6%.

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Basically, the futures contracts are standardized at a 6% coupon security with a $100 face value . The price of 123 represents the value of a 5 year treasury note with a coupon of 6% that is yielding 0.77% + cost of carry. The price of a bond moves inverse to its yield. So as yield drops from 6% to 0.77% the price of the bond or note moves from 100 to 123. For more info google DV01, "bond duration" and yield to maturity.

 

Im simplifying here, in reality there is a little more to it. Firstly amount that the bond rises in relation to the yield is a convex function. If you want to find out more about this google "bond convexity", you need to understand some basic calculus. Secondly, the underlying for the futures contract is based on a basket of similar bonds. The price represents to cheapest to deliver of the bonds in the basket.Google "Cheapest to deliver" or "CTD treasury futures"

 

This might help: U.S. Treasury Futures Conversion Factor Look-Up Tables

 

Basically all the info you need you can find on CME website and wikipedia.

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Conceptually, fixed 6% coupon makes sense but my #s don't tie.

 

As of Friday, ZF closed at 124-225 and according to Bloomberg, 5 Yr Treasury traded around 100-5.5, yielding 0.59%

 

According to my calculations, 5 Yr Treasury that pays 0.625 coupon yields 0.607% (close enough to 0.59 I guess). But when I calculate the yield of ZF trading at 124-225 at 6% coupon, I get 3.09%, much higher than 0.607%. Why?

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