In chapter 22, page 17, the notes say: "being dealt on margin, futures are very volatile. This means that bond futures can be used to match long term liabilities thus overcoming a major limitation of the bond cash market where the longest discounted mean term is about 12 years". I'm trying to see how this would work in practice. By volatility, I presume it means -1/P * dP / di (where P = liab x (1+i)^-n if my liability is a single payment in n years time). I'm not quite sure how I would work out the volatility of a bond future (perhaps apply above formula to (future price - discounted value of bond)(1+i)^time to expiry ) or something and presumebly this will also give a high volatiltiy...but i'm not convinced - surely it would rely on long dated bonds making up the future... But i don't think this is perhaps so important... The bit i really don't get is the sentence "being dealt on margin, futures are very volatile". Can anyone explain why the margin payments would substantially increase the volatility of the contract? Are we saying a bond forward would be much less volatile? [Or perhaps I should just not worry about the details and get back to learning the lists!]
gareth remember the st6 proof of forwards versus future prices was that interest rates affected the return on your margin gain or loss substantially when positively/negatively correlated with asset price, hence discrepency in prices. as a guess,i assume volatility here is sensitivity to interest rates, and if future is thought of as rolling cash position or margin position, then that rolled up gain/loss must be sensitive to interest rates,...maybe that is why the margin dealing adds to volatility.
yep, i agree on that, but how does it add so much sensitivity to interest rates, that suddenly the interest rate future has volatiltiy of the same level of say at > 15 year bond.
