Introduction to Treasuries

At the expiration of a futures contract, the contract is usually settled one of two ways, through a physical settlement involving a delivery of the underlying product or by means of a financial, or cash, settlement to an index or widely accepted price benchmark.

Futures markets trade standardized futures contracts, which means futures that share an underlying asset are interchangeable. They have certain terms that are clearly defined by the futures contract and are usually summed up the contract specifications.

In U.S. Treasury futures, the basis is the price spread, usually quoted in units of 1/32, between the futures contract and one of its eligible delivery securities.

Now that you have a deeper understanding of the U.S. Treasury basis, we need to delve a little deeper into what is known as the cheapest-to-deliver (CTD) security. While each U.S. Treasury futures contract has its own basket of eligible securities for delivery, generally one, or sometimes two, price out to be most efficient for the short position to deliver to the long position. This security is most efficient because it is considered cheaper or cheapest to deliver versus the other alternative securities.

When it comes to measuring risk for fixed income (rates) traders and portfolio managers, they tend to use one or two yardsticks, value of a basis point and modified duration.

Pricing U.S. Treasury bonds, notes and futures can look at first glance to be much different than the pricing of other investment products.

Hedging interest rate risk with CME Group U.S. Treasury futures begins with identifying the futures contract’s cheapest to deliver (CTD) security. Once identified, we can determine the implied basis point value (BVP). BPV is also known as value of a basis point (VBP) or dollar-value of an .01 (DV01). They all refer the same thing, the financial change of the security or portfolio to a change in a 0.01% change in yield. To construct the proper dollar-weighted hedge ratio versus the product or position at risk, we need to first determine the BPV.

Original study notes from CME Group Education