Good Derivatives: A Story of Financial and Environmental Innovation

Chapter 7

Treasury Bond and Note Futures

Spanning the Yield Curve

To everything there is a season, a time for every purpose under the sun.

—Ecclesiastes, 3:1

I talked to Les about my vision to create a family of interest rate futures products that spanned the yield curve. There was a real sense of urgency, as we knew the Chicago Mercantile Exchange was attempting to gain a foothold in the interest rate market. Mike Weinberg, the CME's chairman, had indicated that the exchange had no interest in mortgage interest rate futures because it posed too many problems.¹ CME was terrific at executing ideas developed by others, such as of currency futures. I was relieved that the CME had decided not to compete with the CBOT.

Mark Powers, the CME's chief economist, came up with the idea of a futures contract on Treasury bills.² The CME submitted an application to the CFTC in the fall of 1975, and launched a contract in March of 1976.

Brokers and traders were easily able to determine if the futures contract was cheap or expensive by looking at the relationship between the spot 90-day T-bill and the spot six-month T-bill. If futures were cheap, then there were arbitrage opportunities. Cheap futures also provided the most cost-effective way to go long, and the best way to invest anticipated cash flows three months from now. The user bought the futures and took delivery. If T-bill futures were expensive, then it also provided arbitrage opportunities, the best way for traders to go short and ...