Question

a. How should the parity condition (Equation 17.2) for stocks be modified for futures contracts on Treasury bonds? What should play the role of the dividend yield in that equation?

b. In an environment with an upward-sloping yield curve, should T-bond futures prices on more distant contracts be higher or lower than those on near-term contracts?

c. Confirm your intuition by examining Figure 17.1.

Short answer

Answer

a. Current yield on bonds

b. The current yield exceeds the short-term interest rates

c. Validated

Step-by-step solution

Explanation on role of dividend yield

Current yield on bonds that is found out by dividing coupon interest by price, plays the role of dividend yield.

Explanation in the scenario of upward sloping yield curve

In an environment upward sloping yield curve, the current yield exceeds the short term interest rates.

In this case, the net cost of carry is negative and distant future prices will be lower than near term future prices.

Validation of intuition

In the above figure, the longer-term T-Bond contracts do sell at lower prices than near term contracts.