The Treasury Bond Basis: An in-Depth Analysis for Hedgers, Speculators, and Arbitrageurs

Contents
List of Exhibits
Preface to the Third Edition
Preface to the Second Edition
Preface to the First Edition
1. Basic Concepts
	Treasury Bond and Note Futures Contract Specifications
	Definition of the Bond Basis
		Units
	Conversion Factors
		Characteristics of Conversion Factors
	Futures Invoice Price
	Carry : Profit or Loss of Holding Bonds
	Theoretical Bond Basis
	Implied Repo Rate
	Buying and Selling the Basis
	Sources of Profit in a Basis Trade
	Altemative Summary P/L
	RP versus Reverse RP Rates
2. What Drives the Basis?
	The Short's Alternatives
	Search for the Cheapest Bond to Deliver
	The Best Time to Deliver a Bond
	Rules of Thumb
	The Bond Basis Is Like an Option
	Shifts in the Cheapest to Deliver
	History of the Most Delivered Bond
		Examples of Buying and Selling the Cheapest to Deliver Basis
	The Importance of Embedded Options
3. The Short's Strategic Delivery Options
	Structure of the Delivery Process
		Delivery Process
		Delivery Month
	The Switch Option
		Parallel Changes in Yield Levels
		Changes in Yield Spreads
		The End-of-Month Option
	Timing Options
4. The Option-Adjusted Basis
	An Outline for Pricing the Short's Delivery Options
		Option Structures
		Valuing the Switch and End-of-Month Options
		Expected Basis Net of Carry
		A Word about the Value of Early Delivery
	Practical Considerations
	Volatility and Distribution of Yield Levels
		Yield Betas
		Volatility and Distribution of Yield Spreads
		Consistency between Forward Prices and Expected Forward Prices
		Consistency between Delivery Option Values and Futures Options Values
		Term Repo Specials
		Anticipated New Issues
	The Option-Adjusted Basis in Practice
		If the Basis Is Cheap, Futures Are Rich
		The CTD's BNOC Is Pure Option Value
5. Approaches to Hedging
	DV01 Hedge Ratios and Competing Objectives
	Standard Industry Rules of Thumb
		Rule of Thumb #1
		Rule of Thumb #2
		The Rules of Thumb in Practice
		Shortcomings of the Rules of Thumb
	Spot and Repo DV01s
		Forward Prices as a Function of Spot Yields and Repo Rates
		The Short-Term Independence of Spot Yields and Term Repo Rates
	Creating Synthetic Bonds with Forwards and Futures
	Handling Repo Stub Risk
	Option-Adjusted DV01s
	Yield Betas
	Putting It All Together
	Reckoning the P/L of a Hedge
	Evaluating Hedge Performance
	Working with Durations
	Duration of a Futures Contract
	Appendix to Chapter 5: Better Hedges with Yield Betas?
	Using Yield Betas to Improve Hedges
		Estimating Yield Betas for Treasury Bonds and Notes
	Using Yield Betas to Improve Hedges
	Hedging Something Other Than the Current Long Bond
	When Yield Betas Can Get You into Trouble
		Unstable Yield Betas
		Competing Hedge Ratios When Correlations Are Less Than 1.0
	Competing Hedge Ratios
		Sample Calculations
6. Trading the Basis
	Selling the Basis When It Is Expensive
		Selling the CTD Basis
		Selling the Basis of Non-Cheap Bonds
	Buying the Basis When It Is Cheap
	Trading the Basis of "Hot-Run" Bonds
	Basis Trading When the CTD Is in Short Supply
	Trading the Calendar Spread
		Fair Values for Treasury Note Calendar Spreads
		Profiting from Mispricings in Calendar Spreads
		Patterns in Calendar Spreads
	Practical Considerations in Trading the Basis
	RP Specials
	Term Financing versus Overnight Financing
	Short Squeezes
	The Short Squeeze of 1986
	Taking a Basis Trade into the Delivery Month
7. Volatility Arbitrage in the Treasury Bond Basis
	Overview
	The Options Embedded in Bond Futures
	Calls, Puts, and Straddles
	Two Arenas for Trading Volatility
	The Option-Adjusted Bond Basis
	History of Mispricings
	Volatility Arbitrage
	Report Card
	Examples of Yield Enhancement
	Leverage
	Words of Caution
	Other Applications
8. Nine Eras of the Bond Basis
	The Birth and Maturation of Bond Futures
	Volatility of Yields Since 1977
	Nine Eras of Trading
	First Era: Cash and Carry (1977 and 1978)
	Second Era: Negative Yield curve (1979 through 1981)
	Third Era: Positive Carry (1982 through 1984)
	Fourth Era: The Golden Age of Yield Enhancement (1985 through 1989)
	Fifth Era: Volatility Arbitrage (1990 through 1991)
	Sixth Era: The Death of Gamma (June 1991 through June 1993)
	Seventh Era: The Callables' Last Hurrah (July 1993 through 1994)
	Eighth Era: The Long Dry Spell of the 11-1/4% (1995 through 1999)
	Ninth Era: 6% Factors and the Rebirth of Bond Basis Trading (2000 to ?)
	Changing of the Guard-The Rise of Notes and Fall of Bonds
	Where Do We Go from Here?
9. Non-Dollar Government Bond Futures
	Active Non-Dollar Government Bond and Note Futures
		The Transition to Electronic Trading
		Portfolio Equivalent Value
	Contract Specifications
	Maturities, Settlement Windows, and Last Trading Days
		Cash Settlement of SFE's CGB Contracts
		Up-to-Date Informdtion
	Cash/Futures Relationships
		Key Cash Market Features
		Auction Cycles and Deliverable Sets
		Basis Reference Sheets for Germany, Japan, and the United Kingdom
		Optionality and Futures Mispricings
	Trading Themes in European Bond Bases
		Squeezes of CTD Bonds
		Bonds Exiting the Basket Trades
		New Issuance
	A Word of Caution
10. Applications for Portfolio Managers
	Hedging and Asset Allocation
		Advantages of Using Futures for Hedging and Asset Allocation
		Managing a Portfolio's Duration with Futures
		Calculating the Duration of a Portfolio That Contains Futures
		Example of Targeting Portfolio Duration When Futures Are in the Mix
		Example of Solving for Hedge Ratios Using Target Durations
	Synthetic Assets
		Trade Construction
		How Well Has the Synthetic Asset Strategy Worked?
		Historical Record on Yield Enhancement
		Variations on a Theme
	Caveats
Appendix A. Calculating Conversion Factors
Appendix B. Calculating Carry
Appendix C. Conventions in Major Government Bond Markets
Appendix D. German Federal Bonds and Notes (Bubills, Schatze, Bobls, and Bunds)
Appendix E. Japanese Government Bonds (JGBs)
Appendix F. Government Bonds of the United Kingdom of Great Britain and Northem Ireland (Gilts)
Appendix G. Glossary
Index