Calculating Profit and Loss in Interest Rate Futures
As you have likely discovered, the term commodity can be used to describe a wide array of assets. The formal definition of a commodity is a physical substance or asset that is “interchangeable” in trade. From a more general standpoint, a commodity is any product that trades on a futures exchange. Along with grains such as corn and wheat, commodities also come in the form of financial assets such as interest rate products and currencies. Just as you wouldn’t prefer one bar of gold over another, you likely wouldn’t have a preference between one T-bill over another. The Chicago Board of Trade (CBOT) division of the CME Group futures exchange has recognized this; therefore the CBOT exchange offers standardized contracts to represent each of the government issued fixed income securities known as Treasuries. Similarly, the Chicago Mercantile Exchange division of the CME Group, offers futures trading in a short term interest rate product known as a Eurodollar.
There are several widely traded contracts in the realm of interest rate futures trading. Each of these futures contracts carry slightly differing market characteristics, and in some cases contract sizes, point values, etc. For those unfamiliar with the futures markets, these discrepancies can be overwhelming. However, I hope to deliver the pertinent information clearly in order to make your journey into financial futures trading as pleasant as possible.
Before we cover the basic specifications of each contract, it is important to be aware of a few facts regarding Treasury bond valuation. First, longer maturities will react quicker and more violently to changes in interest rates than shorter maturities. Additionally, the value of a bond (the price in which it is trading) is inversely correlated with interest rates or yields. Accordingly, if interest rates go up bond price will drop and vice versa. Keep these points in mind as you review the details of each contract; it will help you to determine which avenue best suits your risk tolerance and personality.