What are Bond Futures?
A bond future is a contract that obligates the holder to buy or sell a bond at a specific price at a specified future date. The futures market is considered to be very risky and complex. In order to completely understand bond futures, it is necessary to understand their derivative nature in addition to how the futures market functions.
Generally speaking, futures are derivative securities. Buying and selling bond futures does not mean that a person is required to purchase or deliver bonds. Instead, a person who buys or sells bonds is participating in a contractual agreement where he agrees to buy or sell the option or right to buy or sell a bond.
When a person invests in a bond future he may hold the short position or the long position. The short position is the seller, or the person who agrees to deliver the bond at the agreed price and delivery date. He tries to obtain the highest price possible for the sale of futures. The long position is the buyer, or the person who agrees to receive the bond on the specified price and delivery date. The person who holds the long position tries to purchase futures for the lowest price possible.
Many investors prefer to buy and sell futures because they are able to gain more financial leverage than traditional markets. In regards to bond futures, leverage is the ability to control large amounts of bonds with relatively small amounts of capital. The increased leverage leads to higher yields and higher losses. Investors in futures markets are known as hedgers or speculators. Hedgers minimize risk by buying or selling bond futures now, while speculators try to capitalize on risk by buying or selling now based on expectations of falling or rising prices of bonds.
The profits and losses from investing in bond futures are dependent on the daily movement of the market. This significantly differs from the stock market, where investors realize their profits and losses when they buy or sell their stock. Transactions in the futures market are settled on a cash basis each day.
The futures market, including the purchase and sale of bond futures, is regulated by governmental organizations. In the United States, bond futures are regulated by the Commodity Futures Trading Commission (CFTC) and the National Futures Association (NFA). Brokers, who wish to buy, sell or issue bond future contracts, must register with the CFTC and the NFA. The CFTC, NFA and futures exchanges limit the amount of bond futures one person can buy or sell, so they are not able to monopolize the market.
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