Does deliverability enhance the value of U.S. Treasury bonds?

Kuipers, David R.

doi:10.1002/fut.20307

Cited by 8 publications

(10 citation statements)

References 26 publications

(43 reference statements)

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“…When the CTD is squeezed, it trades "on special" with respect to other T-bonds in the repo market, lowering the borrowing costs when the unavailable issue is pledged in a repurchase agreement (Cornell and Shapiro 1989). Finally, note that bonds contending for CTD status usually carry a CTD premium, especially when they are highly predictable (see Kuipers 2008;Sihvonen 2013), thus creating an additional source of price distortion for the 4½% of February 2036 T-bond. Although some of the conditions actuating the entrenchment of a single T-bond for a long period cannot be controlled, removing a single condition would be sufficient to prevent history from repeating itself.…”

Section: Concerns About the Effectiveness Of Futures Hedging If The mentioning

confidence: 99%

History Is Repeating Itself: Get Ready for a Long Dry Spell

Ben-AbdallahRamzi

BretonMichèle

2017

Financial Analysts Journal

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Ramzi Ben-Abdallah is associate professor of finance at UQAM School of Management, Montréal. Michèle Breton is professor of management science at HEC Montréal.T he US Treasury bond futures contract, 1 one of the world's most actively traded futures contracts, is used extensively to hedge long-term interest rate risk. This contract calls for the delivery of $100,000 of a long-term government bond. The notional underlying security is currently a T-bond with a maturity of 15-25 years and a coupon rate of 6%. Because the notional bond is hypothetical and not necessarily traded in the marketplace, the exchange offers short traders the option to choose which issue to deliver among a set of deliverable bonds (the delivery basket). A system of conversion factors is used to adjust for the coupon rate of all the deliverable bonds with respect to the hypothetical reference bond. Because of the imperfection of the conversion factor system, which is based on bond characteristics and does not account for changes in the yield curve, not all eligible grades are equal for delivery to US T-bond futures, and short traders generally find that some issues are more profitable to deliver than others. The security that is the most advantageous for the short trader to deliver is called the "cheapest to deliver" (CTD). 2 A bond's CTD status depends on not only its characteristics (coupon rate and term to maturity) but also market conditions-namely, the market price of the various grades, which is directly related to the yield curve of Treasury securities. Therefore, CTD status is not attached to a particular bond; it varies from contract to contract and even from day to day during the trading period of a particular contract. In the US T-bond futures market, short traders are allowed to deliver on any business day in a delivery month, and thus a variety of bonds may be delivered to T-bond futures contracts. The possibility of delivering any bond within a large delivery basket at any time during the month is meant to alleviate the demand for a single issue and to avoid congestion, or market squeezes.In this article, we recall an episode in the history of US T-bond futures when the concurrence of several conditions gave rise to a progressive entrenchment of the CTD bond over December 1994-December 1999. This entrenchment of the CTD bond had negative repercussions on the futures and bond markets. An analysis of this episode should be enlightening given that a similar uncommon conjunction of conditionsThe recent disappearance of a five-year maturity gap from the set of bonds deliverable to the Chicago Board of Trade Treasury bond futures has resulted in a distinctive configuration, whereby a single T-bond will have the shortest remaining maturity in the delivery basket of bonds for a five-year period. This situation would be inconsequential were three other conditions not simultaneously present, ensuring that this single bond will probably be the cheapestto-deliver bond over the next five years. We show that a similar alignment of conditions ...

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Section: Concerns About the Effectiveness Of Futures Hedging If The mentioning

confidence: 99%

History Is Repeating Itself: Get Ready for a Long Dry Spell

Ben-AbdallahRamzi

BretonMichèle

2017

Financial Analysts Journal

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“…The bond price discount, in term, is determined by its coupon rate, prevailing market interest rates and time to maturity. Other studies find that the idiosyncratic value is attributable to the delivery option of Treasury bonds against Futures contracts, particularly to the ‘cheapest‐to‐deliver’ status of some Treasury bonds (Kuipers, , and Lamoureux and Theocharides, ). Again, the cheapness‐to‐deliver, in term, depends on the bond coupon rate, maturity, and the interest rate environment (see, for example, Hegde, 1988, Kane and Marcus, , and Livingston, )…”

Section: Empirical Findingsmentioning

confidence: 99%

“…Jordan et al () use the cubic spline method to estimate the cash flow value. Other studies use the prices of the generic coupon strips to estimate the cash flow value (see, for example, Kuiper, , Lamoureux and Theocharides, ).…”

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confidence: 99%

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A Long‐Term Perspective on the Determinants of Treasury Bond Stripping Levels

2014

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We examine the proportion of individual Treasury bonds held as strips over the entire history of the STRIPS program. First, we document a secular decline in the Treasury bond stripping levels from 1985 to 2010, coincidental with the long-term decline in the interest rates. This pattern suggests that investors purchase strips to avoid reinvestment risk and to lock in the high interest rates in the 1980s and 1990s. Second, higher coupon and longer maturity bonds are shown to be more heavily stripped. Third, the suspension of new issues of 30-year bonds from 2001 through 2006 created a gap in the maturity structure of Treasury bonds and induced heavy stripping of 30-year bonds issued post 2006. Our findings suggest that stripping is motivated by several factors, including interest rate risk management, tax concerns and market completion.

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“…See, for example, the papers [10,20,22,29] and the references there. Explanations have been offered for some of those inefficiencies as products of short-selling constraints, liquidity, deliverability, etc.…”

Section: Introductionmentioning

confidence: 99%

Economically Irrational Pricing of 19th Century British Government Bonds

Odlyzko

2014

SSRN Journal

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Abstract. British government bonds formed the deepest, most liquid, and most transparent financial market of the 19th century. This paper shows that those bonds had long periods, extending over decades, of anomalous behavior, in which Consols, the largest and best known of these instruments, were noticeably overpriced relative to equivalent securities which offered the same interest rate and the same guarantee of payment. This finding and similar ones for other comparable pairs of British gilts appear to provide the most extreme counterexamples documented so far to the Efficient Markets Hypothesis and to the Law of One Price, and point the way to further investigations on the origins and nature of the modern economy.

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Does deliverability enhance the value of U.S. Treasury bonds?

Cited by 8 publications

References 26 publications

History Is Repeating Itself: Get Ready for a Long Dry Spell

History Is Repeating Itself: Get Ready for a Long Dry Spell

A Long‐Term Perspective on the Determinants of Treasury Bond Stripping Levels

Economically Irrational Pricing of 19th Century British Government Bonds

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