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Then-Current Treasury Forwards Trade Yield Rather Than Price

Article Quant Q&A · Author: HoldBreath
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Summary

The note considers a forward on a Treasury security that will be issued later as the then-current on-the-run bond. Because its coupon is set around the future auction and the new issue is expected to be near par, trading a forward price has little economic purpose under that assumption: the future price is largely anchored near par.

The answer distinguishes the bond price from its yield. A forward yield on the future on-the-run Treasury can be traded, with a payout tied to the difference between the ending yield and the agreed forward rate, multiplied by an annuity value calculated using the ending yield. This structure creates exposure to the future yield even when the bond’s issuance price is expected to be close to par. The explanation is brief and assumes the coupon-setting and near-par behavior described; it does not discuss contract conventions, hedging mechanics, or market liquidity.

Key ideas

  • A future on-the-run Treasury is expected to be issued near par because its coupon is set at auction.
  • Under that assumption, a forward contract on its price has little economic value to trade.
  • The forward yield can still be contracted to express exposure to the future Treasury yield.
  • A yield-forward payoff can scale the yield difference by an annuity value based on the ending yield.
  • The explanation depends on the assumption that the new issue remains close to par.

Tags

Fixed incomeDerivatives pricingUS markets
Full text
# Is there anyone trading Then-Current Treasury Forward?


# Is there anyone trading Then-Current Treasury Forward?












The treasury forward traded for those on-the-run or off-the-run makes sense. You simply trying to hedge the treasury bond already issued by calculating the forward price of the bond.

I was wondering if there is any trade on then-current on-the-run treasury? For example, a forward contract initiated today having underlying as the 5 year on-the-run treasury that is issued 2 years later. If we make the assumption that auction does not alter coupons too much, the forward price would simply be at the Par. In the sense the forward price is already known. Why would anyone make the trade then?

I understand that the then current on-the-run is popular on treasury lock market since the Par Yield is not known. I was wondering if it is traded in the forward market.

## Answer by dm63 (score 3)

https://quant.stackexchange.com/a/69654

You are right, the forward yield of a then-on-the-run Treasury can be traded, but not the forward price. As you point out, the coupon on a new issue is set on the eventual auction date so the price will be close to par on that date, so it makes no economic sense to trade the forward price. The forward yield can be traded - usually the payout is of the form $$(ending yield - forward rate)*annuity value$$where $annuity value$ is calculated using the ending yield. This mimics a bond style payout.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.