One bond is the same as another bond with the same characteristics, so interest rates products also are fungible, and therefore have futures contracts...
One bond is the same as another bond with the same characteristics,
so interest rates products also are fungible, and therefore have futures contracts based on them.
Most of them are based on United States government bond issues, but there's also a Eurodollar futures contract. It's the most heavily traded futures contract in the world. Eurodollars are dollars on deposit in commercial banks outside the United States (including but not exclusively in Europe, despite the "euro" name). (The original definition was only of US dollars on deposit in European banks, but now has expanded.
Eurodollars are outside the jurisdiction of the United States Federal Reserve.
It is heavily used to hedge interest rate risk, especially in line with the London InterBank Offered Rate (LIBOR). It has low margin requirements.
In general, interest rate futures have low volatility, because interest rates don't make large moves. However, this can change. During the summer 1998 financial crisis, for example, when Russia's stock market lost 90% of its value, people all over the world sent money to the United States to be invested in safe U.S. Treasury bonds, greatly increasing that index's volume in a short time.
When thinking of bonds and interest rates, you must remember that the market value of a bond goes down when interest rates in the overall economy go up.
For example, if you buy a bond paying 5% this year, because that's the current interest rate. If the overall interest rate goes up to 6% next year, then your bond's value will go down. That's because people who want to buy bonds can buy new ones paying 6%, so why should they pay the same amount to buy yours when it pays only 5%? They won't.
But if next year's bonds pay on 4%, the value of your bond has gone up, because it's paying 5%. Therefore, buyers will be willing to buy your 5% at a premium to its face value.
In effect, bond buyers always get the current interest rate. What really changes is the price they pay. It's not going to be the face amount of $1,000 unless it's a new bond. If you buy a new bond it will be worth either more or less than its $1,000 face value, depending on its coupon rate of interest.
The other important variable is the term of the bond. Most corporate bonds have long maturities of twenty years. Government bonds varies between Treasury bills (T-bills) of under one year to Treasury bonds (T-bonds) of thirty years, known as the long bond. In the middle are Treasury notes with maturities ranging from two to ten years. They're called T-notes or simply "the note." Their coupon is the benchmark interest rate.
Because interest rates change relatively slowly, bonds with a shorter maturity to expiration date are less risky than longer bonds, which will see more interest rate fluctuations in their lifetimes. That's interest rate risk.
Treasury futures are futures contracts written with government bonds as the underlying asset for future delivery.
T-bills have maturities under one year, and are referred to as discount securities. They do not make interest payments. What happens is that you pay an amount today (at a discount below the par or face value), and receive the total of principle plus interest upon maturity. T-bills have futures contracts, but they are not popular, and so are thinly traded.
