Classifying Bond Futures: Rates Exposure and Embedded Credit Risk
Summary
The document considers whether a bond future belongs in an interest-rate or credit-derivatives category. One response classifies it primarily by its contract mechanics: a bond future does not specify credit events that trigger a credit-derivative payoff, and its price responds to yield changes and the cheapest-to-deliver bond among eligible securities. On that basis, it is generally treated as an interest-rate derivative, with trading desks often grouping it under rates.
A dissenting answer emphasizes that the underlying bond still carries issuer credit risk, including sovereign credit risk. It points to differences in sovereign spreads, their relationship to CDS spreads, and collateral haircuts as evidence that credit quality can affect bond values. The exchange therefore distinguishes operational product classification from economic risk exposure: a contract can be managed in a rates category while still being sensitive to credit conditions. The discussion offers no universal taxonomy rule and reflects different purposes for classifying the same instrument.
Key ideas
- A bond future has no credit-event trigger of the kind specified in a conventional credit derivative.
- Its mechanics depend heavily on interest rates and the cheapest-to-deliver bond in the delivery basket.
- The underlying issuer’s credit quality can still affect bond prices and therefore the future’s value.
- Desk classification as a rates product does not imply that credit risk is absent.
- The appropriate label can depend on whether classification describes contract mechanics or economic exposure.
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Full text
# Is a bondfuture an IRD or a Credit Derivative? # Is a bondfuture an IRD or a Credit Derivative? I need to categorize a BondFuture trade in one of the five major asset classes and I am not sure if it should put it to the interest rate asset class or the credit asset class. A quick (and dirty) thought it to split the bond trade to an IR swap and a CDS. For example, buying a fixed rate bond could be 'linked' with going short on an IR Swap and short a CDS on the issuer. Any other ideas? Thanks ## Answer by atkins (score 1, accepted) https://quant.stackexchange.com/a/29819 It depends on the issuer: if it's a corporate then this would be considered a credit derivative, if it's a highly rated sovereign it would be an interest-rate derivative. As far as I am aware there are no futures currently traded on corporate bonds. ## Answer by Dom (score 1) https://quant.stackexchange.com/a/29820 There is no doubt that it is an interest rate derivative. A credit derivative will have specific credit events in its term sheet such as bankruptcy, failure to pay, obligation acceleration, repudiation, restructuring etc ... that will cause the contract to trigger. There is no such event in a bond futures contract term sheet. It is true that the sovereign issuer of the bond underlying a bond futures contract could (though it is extremely unlikely) default. However from the perspective of the holder of a bond futures contract, that would simply cause a large price movement in the futures contract. It would not make the bond futures contract trigger. Most of the complexity of a bond futures contract comes from the determination of the cheapest-to-deliver. This is based on the term structure of yields and the basket of deliverable bonds. All of the required understanding of a bond future is based on interest rate issues. None of these would be handled via a CDS or interest rate swap. ## Answer by Mehness (score 1) https://quant.stackexchange.com/a/31376 Good lord - sovereign debt crisis anyone? 2010? Sorry it's a hybrid like any bond, not just corporates bonds, that way of looking at the world is as aged as thinking that banks can always fund at LIBOR, it is emphatically BOTH a credit derivative and an interest rate derivative. To ignore credit risk on a european government bond and to use use words such as 'highly rated government bond' is completely to ignore the aftermath of the credit crunch. After all, why do european govvies trade at differing asset swap spreads if not for differing credit quality between eg Greece / Italy / Germany. Why do these spreads loosely follow sovereign CDS spreads (albeit on a mean reverting basis given liquidity factors influencing bond CDS basis). Why does the ECB impose varying haircuts on EGBs posted as collateral if not for reasons of credit quality? All bonds have credit risk, doesn't matter if they're issued by a government, or a corporate, or a bank. Sovereigns default, they have non-zero credit spreads. Please let's not repeat the mistakes of the past! All that having been said, as the OP is forced to make a choice, I do agree that most banks will rightly classify and trade these in their rates pod. I just wanted to be clear that this is owing to being forced to classify, than for the fact that there is no credit risk in the product. Anyone who has traded through the sovereign debt crisis might feel this distinction.
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