Futures on Govt Bonds

[Arka Bose]

I have a doubt regarding Futures on government bonds.

Rise in interest rates decline value of the bonds.
But what about futures? The Valuation of futures would be on the basis of the spot price which will be lower but the risk free rate will be higher, thus they will be offsetting each other?

 

[David Harper CFA FRM]

Hi @arkabose

Yes! I agree. See XLS @ https://www.dropbox.com/s/qd7lps3fmsb3fse/0708-futures-tbond.xlsx?dl=0

• 1st sheet implements Hull's example 6.2; e.g., interest rate = 10.0%
• 2nd sheet simply increases rate to 11.0%, ceteris paribus. This increases the futures price! Of course, the fallacy is that the spot price of the CTD bond is unchanged. In reality, if the rate increases, then the spot price will decrease. But your point remains valid: as the increased rate implies a higher cost of carry (COC), the increases rate will have an offsetting impact. Thanks,