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my question is about treasury bond futures contracts
the textbook says they are quoted as 100 - the yield percentage per year, and its done like this to show that lower interest rates have higher selling prices via the bond formula which is:
P = C [ 1 – (1 + i )-n / i ] + A ( 1 + i )-n
i = interest rate per period, as a decimal
n = number of coupon periods
C = periodic coupon payments
A = face value of the bond
P = price of the bond
(btw -n is an exponential)
i used the formula and its true, higher interest rates have a lower price of the bond. but, why? it says in the textbook all australian commonwealth treasury bond futures contracts are $100 000 at 6% p.a. bond, so wont it all add up to 100 000 anyway, regardless of the futures interest rate? whats the point?
sorry if im missing the obvious
 
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higher interest rates gives you a lower price for the bond because given a fixed amount of future cash flow, the "price" (aka the equivalent present value) of these needs to be adjusted down to give you the required interest rate return (aka , the return on your money)
to make a simple example. say you receive $100 in the future.
if the price of this is 90, then the implied return will be roughly 10%
if the price is instead 80, then the implied return will be roughly 20%
the lower the price, the more opportunities for an interesting return. and interest rates (the ytm) should be seen as your return.
when you read that all australian bonds are 100k, they just mean that their FACE value is 100k. not their price. the price will vary depending on the prevailing interest rates of the moment. if they are higher than the coupon payments, then your bond will be selling at a discount. could be quoted at 97%. meaning the bonds price is 97k. and vice versa.
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I'm a little rusty on my finance formulas, but in principle, interest rates have an inverse relationship with bond price because interest rates are a signal of inflation. The higher the inflation, the less your real return is on your coupon and yield to maturity; vice versa for lower inflation.
For your second question, the point of a bond is to hedge against equity volatility so it will return a set amount in the future. That is why it is vulnerable to inflation and the interest rate. Keep in mind though that you'd also be receiving a coupon throughout the time period so you're not just receiving the $100,000. That is also why zero coupon bonds often sell for less than face value.
A third point to note is that often times, in reality, bonds are also traded in the secondary market. While the actual bond contract may return a set coupon and final yield, the contract itself will have a value seperate from this calculation based on supply and demand in the secondary market. That's why if you look at the returns on bond funds in the last 30 years, their return is actually higher than equity.
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scratch that.. didnt realize u were speaking about futures contrcts
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On May 14 2009 16:47 TheFlashyOne wrote:
higher interest rates gives you a lower price for the bond because given a fixed amount of future cash flow, the "price" (aka the equivalent present value) of these needs to be adjusted down to give you the required interest rate return (aka , the return on your money)
to make a simple example. say you receive $100 in the future.
if the price of this is 90, then the implied return will be roughly 10%
if the price is instead 80, then the implied return will be roughly 20%
the lower the price, the more opportunities for an interesting return. and interest rates (the ytm) should be seen as your return.
when you read that all australian bonds are 100k, they just mean that their FACE value is 100k. not their price. the price will vary depending on the prevailing interest rates of the moment. if they are higher than the coupon payments, then your bond will be selling at a discount. could be quoted at 97%. meaning the bonds price is 97k. and vice versa.
so if you buy face value $100K then interest rates go higher and you sell at the time of high interest you get less than what you paid?
lol i didn't answer johncoltrane's question but i'm also interested (not a finance person :S)
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and gchan, bonds have never outperformed stocks .  especially not on the long period you're suggesting.
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is my formula correct? i tried using 7% futures interest and 6% interest, wouldnt they both equal 100k?
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opps sorry, didnt realize you were speaking about futures contract.
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On May 14 2009 16:50 poisongirl wrote:Show nested quote +On May 14 2009 16:47 TheFlashyOne wrote:
higher interest rates gives you a lower price for the bond because given a fixed amount of future cash flow, the "price" (aka the equivalent present value) of these needs to be adjusted down to give you the required interest rate return (aka , the return on your money)
to make a simple example. say you receive $100 in the future.
if the price of this is 90, then the implied return will be roughly 10%
if the price is instead 80, then the implied return will be roughly 20%
the lower the price, the more opportunities for an interesting return. and interest rates (the ytm) should be seen as your return.
when you read that all australian bonds are 100k, they just mean that their FACE value is 100k. not their price. the price will vary depending on the prevailing interest rates of the moment. if they are higher than the coupon payments, then your bond will be selling at a discount. could be quoted at 97%. meaning the bonds price is 97k. and vice versa. so if you buy face value $100K then interest rates go higher and you sell at the time of high interest you get less than what you paid? lol i didn't answer johncoltrane's question but i'm also interested (not a finance person :S)
you could lose money if you don't hold the bond long enough , yes.
say you buy at whatever price, tommorow the rates go up, and you sell , then yeah, you have a net loss. but if you hold the bond for a certain time , during which the interest rates go up, two things will happen;
1- your return is decreased because the interest rates went up
2- you actually have earned a return because you held the bonds for a certain time. so you have earned accrued interest ( which will be reflected in the price you receive for your bonds.)
whether or not you actually lose money will depend on the netting of these two factors. but #1 will really have an adverse effect on your return.
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sorry if i was being confusing
i worked out that at 7.25%, the P = about $91216, but at 7% the P = $92893. Does this mean if you sell it for those prices? and you pay the remaining interest to the holder? so it always = 100k ?
also im not really understanding the relationship between the futures contract and the bond. How to do you generate profit by buying and selling? it says the periodic coupon payments always stays at 6% and they are payed twice a year, so the C = $3000. If i sell it for a lower interest (the i) and get a bigger P, wont i just have to pay the interest back anyway?
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On May 14 2009 17:03 TheFlashyOne wrote:Show nested quote +On May 14 2009 16:50 poisongirl wrote:On May 14 2009 16:47 TheFlashyOne wrote:
higher interest rates gives you a lower price for the bond because given a fixed amount of future cash flow, the "price" (aka the equivalent present value) of these needs to be adjusted down to give you the required interest rate return (aka , the return on your money)
to make a simple example. say you receive $100 in the future.
if the price of this is 90, then the implied return will be roughly 10%
if the price is instead 80, then the implied return will be roughly 20%
the lower the price, the more opportunities for an interesting return. and interest rates (the ytm) should be seen as your return.
when you read that all australian bonds are 100k, they just mean that their FACE value is 100k. not their price. the price will vary depending on the prevailing interest rates of the moment. if they are higher than the coupon payments, then your bond will be selling at a discount. could be quoted at 97%. meaning the bonds price is 97k. and vice versa. so if you buy face value $100K then interest rates go higher and you sell at the time of high interest you get less than what you paid? lol i didn't answer johncoltrane's question but i'm also interested (not a finance person :S) you could lose money if you don't hold the bond long enough , yes. say you buy at whatever price, tommorow the rates go up, and you sell , then yeah, you have a net loss. but if you hold the bond for a certain time , during which the interest rates go up, two things can happen; 1- your return is decreased because the interest rates went up 2- you actually have earned a return because you held the bonds for a certain time. so you have earned accrued interest ( which will be reflected in the price you receive for your bonds.) whether or not you actually lose money will depend on the netting of these two factors. but #1 will really have an adverse effect on your return.
so if interest rates go down, i get a bigger return? thats how futures contracts work, they interest negotiated stays the same no matter what happens to the real interest rates? is that the only way to make money? im not really understanding the point of the bond price thingy.
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OP, what's really weird is that you're asking a question about Bonds futures contracts, which are a derivative instrument. yet you don't seem to understand basic relationships like price vs interest rates. i guess you're just taking an introductory course to finance. in which case they should NOT be teaching you derivatives since it's a complex topic. basically , what most people do is take finance 1 ( basic mathematical formulas), then finance2 (corporate finance)...and then..and only then do they take a class about derivatives. really weird. (kangaroos and the accent aren't the only weird thing in Australia)
a derivative is a financial instrument that derives its price based on an underlying asset. speaking about bonds futures, the bonds futures will derive their prices based on whatever the prevailing bonds prices are. you could go long on the bonds futures (get into a contract to buy the bonds at a fixed price in the future) or go short on the bonds , which is you get into a contract to sell the bonds at a fixed price in the future. if you go long, you stand to make money if interest rates go down. and vice versa.
to make it simple, futures bond prices depend on the prevailing price of the bonds which themselves are depending on the current interest rates. low interest rate = high priced bond = high futures bonds price.
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On May 14 2009 17:18 TheFlashyOne wrote:
OP, what's really weird is that you're asking a question about Bonds futures contracts, which are a derivative instrument. yet you don't seem to understand basic relationships like price vs interest rates. i guess you're just taking an introductory course to finance. in which case they should NOT be teaching you derivatives since it's a complex topic. basically , what most people do is take finance 1 ( basic mathematical formulas), then finance2 (corporate finance)...and then..and only then do they take a class about derivatives. really weird. (kangaroos and the accent aren't the only weird thing in Australia)
a derivative is a financial instrument that derives its price based on an underlying asset. speaking about bonds futures, the bonds futures will derive their prices based on whatever the prevailing bonds prices are. you could go long on the bonds futures (get into a contract to buy the bonds at a fixed price in the future) or go short on the bonds , which is you get into a contract to sell the bonds at a fixed price in the future. if you go long, you stand to make money if interest rates go down. and vice versa.
to make it simple, futures bond prices depend on the prevailing price of the bonds which themselves are depending on the current interest rates. low interest rate = high priced bond = high futures bonds price.
how does the return system work and how does the bond formula fit into all this?
is this how it works:
i buy a treasury futures bond from the govt treasury at 6% coupon payment, and i sell it to someone else before the maturity in 10 years for 5%. i get a profit? because the lower the rate the higher the price? also, i get interest for the period i kept the futures bond, and then once i sell it, the person i sell it to gets the interest?
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I think you mix up ordinary financial assets and derivatives. As far as I know, there is no such thing as "treasury futures bond". There is the treasury bond itself, and the other one is just a contract on selling/buying bonds on a fixed price. At least that's what I think, I'm not really an expert. As far as I know, you dont get coupons for derivatives. The fixed price on the futures market is really good for some businesses, they can calculate their cash flow more accurately. Then it's the market that gives a price for these instruments depending on the current interest rate.
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ahh
the text book says 'The Commonwealth Treasury bond futures contract is based on a 6 per cent per annum fixed interest bond with a face value of $100 000 and paying half-yearly coupons'
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again..its weird that you're asking question about derivatives. you can't buy a treasury futures bond from the government. what you're doing is entering a contract with someone else (a counter party, a bank, someone like you..etc.. but not the GVT). the GVT issues the bonds. and those bonds are used to make a bet with someone else (who doesn't need to own the bonds either). you're betting against him. if you're long (committing to buy in the future at a fixed price), you're betting interest rates will go down. and that's it. you don't receive interest or anything, you don't collect anything from the bonds themselves. the money you make or lose depends on the price fluctuation of the futures bonds price.
im going to bed ^___^ 5 am here.  i might help tomorrow but seriously , go see your teacher -.-V
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Its ok, my speech isnt on this, it was just sort of branching off the topic of my speech so i was trying to understand it a little. but its fine, its not directly related to it so i should be fine
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On May 14 2009 17:55 TheFlashyOne wrote:again..its weird that you're asking question about derivatives. you can't buy a treasury futures bond from the government. what you're doing is entering a contract with someone else (a counter party, a bank, someone like you..etc.. but not the GVT). the GVT issues the bonds. and those bonds are used to make a bet with someone else (who doesn't need to own the bonds either). you're betting against him. if you're long (committing to buy in the future at a fixed price), you're betting interest rates will go down. and that's it. you don't receive interest or anything, you don't collect anything from the bonds themselves. the money you make or lose depends on the price fluctuation of the futures bonds price. im going to bed ^___^ 5 am here. i might help tomorrow but seriously , go see your teacher -.-V
yeah, seriously what r u like 10?
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EPT
