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GARY FRITZ WROTE,
Date: Thu, 25 Nov 1999 08:39:35 -0700
From: "Gary Fritz" <fritz@xxxxxxxx>
To: omega-list@xxxxxxxxxx
Subject: Re: 6% data in Bonds - effect
Message-Id: <199911251539.IAA61453@xxxxxxxxxxxxxxx>
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Robert Bianchi <R.Bianchi@xxxxxxxxx> wrote:
> The bottom line in moving to the 6% coupon bond futures will show a
> small effect on the historical data based on the RELATIVE VALUE
> movement between the 8% and the 6% bond in historical terms. This
> is because the 6% coupon bond has a longer duration (i.e. interst
> rate risk) than the 8% coupon. Normally, these 2 bonds would trade
> up and down tick for tick apart from the following conditions:
>
>Thanks, Robert. Tick for tick, eh? Does that mean that I could
>merge 8% data and 6% data just by adding/subtracting the difference
>between the two? Would that be "close enough" for any practical
>purposes?
>
>That would be a lot more attractive to me than complex multiplicative
>factors. In addition to being simpler, it would also maintain the
>even tick values of the old data.
>
>Thanks!
>Gary
At the CBOT web site they show you an example of the Dollar volatility
difference between the 8% and 6% coupon 30Y T-Bond.
(courtesy from the CBOT)
E.G.
Trader A goes long 100 lots in the 8% T-Bond futures at 123.02
* if yield immediately drops 25 basis points, the profit is +$286,032
* if yield immediately rises 25 basis points, the loss is -$277,101
Trader B goes long 100 lots in the 6% T-bond futures at 102.28
* if yield immediately drops 25 basis points, the profit is +$293,144
* if yield immediately rises 25 basis points, the loss is -$281,732
The difference in price volatility betweeen the 8% and the 6% is
* if yield falls 25 basis points you make $7,112($293,144-$286,032) on 100
lots (or $71.12 on 1 lot)
* if yield rise 25 basis points you lose -$4,631 ($277,101-$281,732) on
100 lots (or $46.31 on 1 lot)
If you think your trading system is susceptible to blow due to a $71 change
in price vol on a 1 lot position when there is a 25 basis move in YIELD
then I would say your system is VERY, VERY sensitive. I would argue that
most decent systems could handle this very small change.
This is the example of theT-Bond. The price vol difference in the 10Y Note
and 5Yr Note is even smaller.
With regards to the cheapest-to-delivery (CTD) factor, this will affect the
physical bond price makers who deliver on the futures contract but not the
futures. The futures contract will trade as per normal and it will the
physical bond price makers that will need to decide and switch to the
physical bonds that they will need as a hedge to deliver on the contract.
They will favour the cheapest bond in relative value terms. In other
words, this will affect the "relative value" between the various physical
bonds depending on where the bond futures price and where yield ends up
trading in the future. In other words do not worry about this.
If you want to learn about bonds and they way they are priced, the bond
"bible" comes from an author called Frank Fabozzi.
Obviously, I am not an advisor or guru so there is a DISCLAIMER to
everything that I said.
You know, those yanks will even sue you for sneezing.
I hope this helps!
Robert Bianchi
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