Ultra Long Bond Contract

September 22nd, 2009 2:27 pm | by John Jansen |

Here is a link to the CME press release on the new contract. I am going to reprise here my comments (via cutting and pasting ) on the effect that this new instrument will have on swap spreads. It is at the very end of my previous post and deserves a higher profile than that:

The Chicago Board of Trade announced that beginning in Q1 2010 that it will trade an Ultra Long Bond contract into which the deliverable issue will be 25 years or longer.

This change should finally normalize the 30 year swap spread which has been NEGATIVE for most of the last year.

One of the reasons cited for the negative spread is that many investors prefer to keep cash on the balance sheet and prefer the notional nature of the swap transaction.

If I buy $ 1billion Long Bonds I must part with the cash. If I receive on the same amount of swaps,I am just exchanging cash flows.

The same result will occur with this new contract as buyers of the contract are defacto long the cheapest to deliver bond against the new contract.

So it will create demand for those bonds and investors can have that duration exposure vis the futures contract without parting with cash money.

So look for 30 year swap spreads to normalize over time.

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  1. 7 Responses to “Ultra Long Bond Contract”

  2. By Chicken on Sep 22, 2009 | Reply

    This is a little over my head – sounds like good news, but for whom?

  3. By Bman on Sep 22, 2009 | Reply

    dont’ you still have to post collateral to enter a swap – and haven’t those requirement amounts increased since last fall’s destruction? If no to both, then hop on board I supppose.

  4. By Bman on Sep 22, 2009 | Reply

    I wonder if some of the “strong demand for longer duration” is coming from the Treasury, which must be considering auctioning more longer-term debt as they become aware that it cannot issue short-term at these rates levels indefinately.

  5. By frankl on Sep 22, 2009 | Reply

    Mr.Jansen, I *LOVE* your diction and usage of the phrase “cash money” – did you ever work on a repo desk?? priceless – keep it up

    as to Bman’s query about collateral, that amount is only about the exposure due to the difference in expected cashflows of the nearest reset, which is orders of magnitude lower than the notional of the swap – so yes, collateral is required, but it’s tiny

  6. By John Jansen on Sep 22, 2009 | Reply

    I never worked on a repo desk but if I ran a primary dealer I would insist that every college graduate who joins to sell or trade should have a stint on a repo desk. It is the guts of the operation.

  7. By Tyler K on Sep 22, 2009 | Reply

    “haven’t those requirement amounts increased since last fall’s destruction? ”

    In regards to the point of markets being under pressure, I would expect that more swaps were engaged upon the condition of periodic marking-to-market over the course of the swaps lifetime in order to mitigate the credit risk (which, of course, can fluctuate between both sides as the value of the swap itself fluctuates away from the initial zero value). Doing so, in essence, means you end up entering into a series of swaps across the intended lifetime.

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