Financial Markets and Institutions (2-downloads)

Treasury Bonds (CBT)-$100,000; pts. 32nds of 100%

\

Open

High

Low

Settle

Change

Open Interest

June

123-00

123-17

122-12

122-25

3.0

719,746

Sept

122-15

123-00

121-28

122-08

4.0

29,917

under the “Interest Rate” heading of the “Futures

Prices” columns. An excerpt is reproduced here.

Source: Wall Street Journal May 19, 2010, p. C 9.

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Chapter 24 Hedging with Financial Derivatives

595

sellers get $111,000 from selling the futures contract but have to pay only $110,000

for the Treasury bonds that they must deliver to the buyer of the contract, and the

$1,000 difference is their profit. Because this profit involves no risk, traders will

continue to sell the futures contract until its price falls back down to 110, at which

price there are no longer any profits to be made. The elimination of riskless profit

opportunities in the futures market is referred to as arbitrage, and it guarantees

that the price of a futures contract at expiration equals the price of the underly-

ing asset to be delivered.

1

Armed with the fact that a futures contract at expiration equals the price of

the underlying asset, it is even easier to see who profits and loses from such a con-

tract when interest rates change. When interest rates have risen so that the price

of the Treasury bond is 110 on the expiration day at the end of June, the June

Treasury bond futures contract will also have a price of 110. Thus, if you bought

the contract for 115 in February, you have a loss of 5 points, or $5,000 (5% of

$100,000). But if you sold the futures contract at 115 in February, the decline in price

to 110 means that you have a profit of 5 points, or $5,000.

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