Tag: Automated Trading Accounts

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Understanding the FOMC Report

The Federal Reserve, also referred to as the Fed, is the central banking system of the United States and is responsible for guiding U.S. monetary policy. Economic policy announcements and public statements by the Federal Reserve are among the most highly anticipated trading events of the year, since implications for financial markets are so widespread.

The Fed is responsible for buying and selling U.S. government securities in the financial markets and setting interest rates and reserve requirements. The Fed by definition is dual-mandated, Fed policy makers are expected to achieve both stable prices and maximum employment. As a result, public statements made by the Fed and its governors are closely watched by traders, since even the smallest changes in monetary policy and federal funds rates can create large market-moving events.

The Federal Open Market Committee

The Federal Open Market Committee (FOMC) consists of twelve members: the seven members of the Board of Governors of the Federal Reserve System, the president of the Federal Reserve Bank of New York and four of the remaining eleven Reserve Bank presidents, who serve one-year terms on a rotating basis.

For traders, FOMC meetings are a time of particular volatility because any change in federal fund rates can affect a range of economic variables such as short-term interest rates, foreign exchange rates, long-term interest rates, employment output and prices of goods and services.

The FOMC meets eight times a year to discuss monetary policy changes, review economic and financial conditions and assess price stability and employment output.  These meetings take place every six weeks. Four of these meetings feature a Summary of Economic Projections (SEP) followed with a press conference by the chair. The minutes of the scheduled meetings are released three weeks after the date of the policy decision.

Trading on the Fed’s Decisions

The Fed provides a wealth of data that can influence the markets. In addition to the Fed’s headline interest rate, traders also study the post-meeting press releases, which highlight the state of the economy. Since some information contained in the press release may look forward to policy changes at future meetings, the contents of this release carry a risk of catching market participants off guard. It is for this reason that traders pay particular attention to press releases, speeches and other public appearances by Fed members that occur between FOMC meetings.

There are a number of factors to think about when trading before and after FOMC meeting announcements, but with a little insight and thorough preparation it is an event that offers numerous opportunities for traders throughout the year.

If you have questions send us a message or schedule an online review .

Regards,
Peter Knight Advisor

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Interest Rate Education Homepage

In the latest Trader’s Edge video, we explore the relationship between U.S. Treasury securities and the USD/JPY exchange rate, and the opportunities it can present with Treasury yields on the rise. Topics include:

• Recent weakening of the U.S. dollar vs. the Japanese yen
• Why rising yields in U.S. rates have not strengthened the dollar
• How a higher yield and weaker dollar affects Japanese holders of U.S. Treasuries
• Why Japanese investors could be on verge of selling U.S. Treasuries
• How higher Treasury yields could help strengthen the USD/JPY exchange rate

If you have questions send us a message or schedule an online review .

Regards,
Peter Knight Advisor

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Interest Rate Education Homepage

The U.S. Treasury Bond market is the largest and deepest government debt market in the world. Individual U.S. Treasury Notes and Bonds provide important benchmark yields at various points along the yield curve.

Trading the slope of the U.S. Treasury curve using futures contracts involves the execution of an inter-commodity spread. One very common and widely quoted yield curve spread is the twos versus tens yield spread. This spread compares and reflects the difference in yields between the current U.S. Treasury 10-Year note and the current U.S. Treasury 2-Year note.
Watch this video to learn more about this spreading technique.

If you have questions send us a message or schedule an online review .

Regards,
Peter Knight Advisor

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Interest Rate Education Homepage

If you have questions send us a message or schedule an online review .

Regards,
Peter Knight Advisor

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Privacy Notice

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Interest Rate Education Homepage

Regards,
Peter Knight Advisor

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Interest Rate Education Homepage

Treasury Price/Yield Calculator

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

Cash bonds and futures based on U.S. Treasury securities do not trade in decimal format but in full percentage points, plus fractions of a 1/32 of par value. For example, if you were to see a quote on a broker/dealer screen showing U.S. Treasury prices you might encounter something like this:

10 YR   2.250  2/15/27            99-032 / 99-03+  10/20

This quotation would indicate the current on-the-run (OTR), or most recently auctioned, 10-year note with a coupon of 2.250% and a maturity date of February 15, 2027 is currently 99-032 bid and offered at 99-03+, $10 million bid with $20 million offered.

The bid-side price of 99-032 is not 99.032 but rather 99 full points of par value plus 3.25 1/32s of a point. In the cash market, the third digit might be two, plus or six. The two constitutes 2/8, or ¼, of a 1/32. A plus constitutes ½ of 1/32, and six constitutes 6/8, or ¾, of 1/32. So our bid-side quote converted from 1/32 to a decimal would be: 99-032 (1/32s) = 99.1015625, or 99.1015625 percent of par. The offer-side price would convert to 99-03+ = 99.109375.

If you were to view a U.S. Treasury futures price quotation you might encounter something like this: TNM7 134-010/134-015.

The same concept as the cash market convention applies. The bid-side quote represents 134 full points plus 1/32 of a point. The converted price into decimal would be 134-010 = 134.03125, and so forth for the offer-side price. In futures you might see 134-012 for 1-1/4 (1/32), 134-015 for 1-1/2 (1/32), or 134-017 for 1-3/4 (1/32).

While seemingly complicated, it becomes second nature after a while. Cash Treasuries and futures based on U.S. Treasuries trade in points and fractions of points (1/32).  But when doing any mathematical calculations, we must first convert from 1/32 to decimal, do the calculation, then convert back to 1/32 price convention.

If you have questions send us a message or schedule an online review .

Regards,
Peter Knight Advisor

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Forward Rate Agreements (FRA)

A Forward Rate Agreement (FRA) is a forward contract on interest rates. While FRAs exist in most major currencies, the market is dominated by U.S. dollar contracts and is used mostly by money center banks.

An FRA is a cash-settled contract between two parties where the payout is linked to the future level of a designated interest rate, such as three-month LIBOR. The two parties agree on an interest rate to be paid on a hypothetical deposit that is to be initiated at a specific future date. The buyer of an FRA commits to pay interest on this hypothetical loan at a predetermined fixed rate and in return receive interest at the actual rate prevailing at the settlement date.

Example Trade

Assume that in December 2017, a June 2017 Eurodollar futures is priced at 99.10.  This price reflects the market’s perception that by the June 2017 expiration, three-month LIBOR rates will be .90% (IMM Price convention= 100 – 99.10 = .90%).  Eurodollars are really a forward-forward market and their prices are closely linked to the implied forward rates in the OTC market.

Eurodollars and FRAs

Just as stock index futures reflect the cash S&P 500 market and soybean futures reflect the spot soybean market, Eurodollar futures should price at levels that reflect rates or implied rates in the FRA market. In addition, Eurodollar futures prices directly reflect, and are a mirror of, the yield curve. This is intuitive if one considers that a Eurodollar futures contract represents a three-month investment entered into N days in the future. Certainly, if Eurodollar futures did not reflect IFRs, an arbitrage opportunity would present itself.

Example

Consider the following interest rate structure in the Eurodollar (Euro) futures and cash markets. Assume that it is now December. Which is the better investment for the next six months:

• Invest for six months at 0.80%;
• Invest for three months at 0.70% and buy March Euro futures at 99.10 (0.90%); or
• Invest for nine months at 0.90% and sell June Euro futures at 98.96 (1.04%)?

Assume that these investments have terms of 90- days (0.25 years), 180-days (0.50 years) or 270- days (0.75 years).

March Euro Futures 98.10 (0.90%)

June Euro Futures 98.96 (1.04%)

Three-month Investment 0.70%

Six-month Investment 0.80%

Nine-month Investment 0.90%

The return on the first investment option is simply the spot six-month rate of 0.800%. The second investment option implies that you invest at 0.700% for the first three months and lock in a rate of 0.900% by buying March Eurodollar futures covering the subsequent three-month period. This implies a return of 0.800% over the entire six-month period.

The third alternative means that you invest for the next 270 days at 0.90% and sell June Eurodollar futures at 1.04%, effectively committing to sell the spot investment 180 days hence when it has 90 days until maturity. This implies a return of 0.83% over the next six-months.

The third alternative provides a slightly greater return of 0.83% than does the first or second investment options with returns at 0.80%.

Eurodollar futures prices reflect IFRs in the FRA market because of the possibility that market participants may pursue arbitrage opportunities when prices become misaligned. Thus, one might consider an arbitrage transaction by investing in the third option at 0.83% and funding that investment by borrowing outright at the term six-month rate of 0.80%. This implies a three basis point arbitrage profit.

Conclusions

This module demonstrates the close linkage of the FRA and Eurodollar futures market. These contracts allow a firm to replace floating interest rates with fixed interest rates or vice-versa. FRAs are customized contracts that can be obtained through investment banks. These banks hedge the risk of these products by using Eurodollar futures. In hedging the sale of a forward contract with futures, the marking to market feature of futures must be considered. As a result, the pricing of FRAs is very competitive and bid-ask spreads are very narrow as arbitrage opportunities keep prices in the two markets very closely aligned.

If you have questions send us a message or schedule an online review .

Regards,
Peter Knight Advisor

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