Futures are derivative instruments that commit parties to the contract to either buy or sell an underlying asset on a certain date for a certain price. The underlying asset on which Treasury bond futures contracts are based is a United States Treasury bond, which is a type of debt instrument issued by the Treasury. These instruments allow investors to protect themselves against volatility in the interest rate.
Treasury bond futures function like commodity futures do, except that the seller promises to deliver Treasury bonds rather than corn or oil. A Treasury bond is one of several types of debt instruments issued by the United States Treasury, which generate income for the Treasury in exchange for payments that they must give to investors at a later date. Treasury products are called by different names according to their maturities and the frequency with which they pay coupons to the investor. A bond pays coupons every six months, and its maturity date is 30 years after its issue.
After World War II, the representatives at the Bretton Woods summit agreed to a system of fixed exchange rates. The system gradually broke down, and in 1971 President Richard Nixon removed the dollar from the gold standard. This action led to volatility in exchange rates and interest rates. These fluctuations made it difficult for investors to make decisions about long-term investments because the cost of holding money in certain types of investments was always changing. The first Treasury bond future was created by the Chicago Board of Trade in 1975 to respond to the volatility.
Investors can purchase or sell Treasury bond futures in combination with other assets to create a hedged portfolio. This means the investor is protected against changes in the interest rate that could affect his expected returns on his investments. The instruments can also be used to lock in future prices if investors think conditions in the future will be unfavorable compared to the market expectations reflected in futures prices. Some investors simply trade on the futures market, trying to make money by trading futures contracts with different underlying assets for one another.
Treasury bond futures are particularly useful to investors because they are highly liquid. This means the secondary market, on which investors trade already written futures contracts, has a high trading volume. Investors can thus count on selling or buying contracts on short notice. Liquidity enables investors to plan strategies and execute them without the interruption of waiting to find a buyer or a seller.
