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I need to categorize a BondFuture trade in one of the five major asset classes and I am not sure if it should put it to the interest rate asset class or the credit asset class.

A quick (and dirty) thought it to split the bond trade to an IR swap and a CDS.

For example, buying a fixed rate bond could be 'linked' with going short on an IR Swap and short a CDS on the issuer.

Any other ideas?

Thanks

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  • $\begingroup$ Given that Bond Futures are traded on highly rated sovereigns (Germany, USA) it seems odd to consider them credit risk related. They seem to me like a long term IR instrument. They are a bet on the direction of 10 year govt i.r. in Germany, US etc.. However I am not familiar with regulations, or current practices, many of which I find difficult to understand. $\endgroup$ – noob2 Aug 23 '16 at 14:42
  • $\begingroup$ I agree with you about bondfutures not trading on corporates, but, actually my question is, in general, if there are any derivatives on corporate bonds (apart from CDSs) where should they be categorized? $\endgroup$ – sen_saven Aug 24 '16 at 12:58
  • $\begingroup$ Well then if they are on Corporate Bonds they are Credit. But I don't know any other than CDS. $\endgroup$ – noob2 Aug 24 '16 at 14:45
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It depends on the issuer: if it's a corporate then this would be considered a credit derivative, if it's a highly rated sovereign it would be an interest-rate derivative.

As far as I am aware there are no futures currently traded on corporate bonds.

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  • $\begingroup$ arbitrary distinctions between corporates and sovereigns as regards credit risk were blown out of the water in the sovereign debt crisis, regardless of the trading pods managing the vanilla underlying risk. Any desk using such bonds as collateral / contributing to exotic payoffs will 100% be modelling (possibly) correlated credit risk in the bonds. Sovereign credit spreads are not zero, corporates can often trade inside sovereigns. $\endgroup$ – Mehness Dec 7 '16 at 16:43
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There is no doubt that it is an interest rate derivative. A credit derivative will have specific credit events in its term sheet such as bankruptcy, failure to pay, obligation acceleration, repudiation, restructuring etc ... that will cause the contract to trigger. There is no such event in a bond futures contract term sheet.

It is true that the sovereign issuer of the bond underlying a bond futures contract could (though it is extremely unlikely) default. However from the perspective of the holder of a bond futures contract, that would simply cause a large price movement in the futures contract. It would not make the bond futures contract trigger.

Most of the complexity of a bond futures contract comes from the determination of the cheapest-to-deliver. This is based on the term structure of yields and the basket of deliverable bonds. All of the required understanding of a bond future is based on interest rate issues. None of these would be handled via a CDS or interest rate swap.

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  • $\begingroup$ an ISDA defined terminal payoff is not a prerequisite for a contract to have credit risk. Any bond itself is a credit derivative (most often a credit-rate hybrid), totally independently of an ISDA defined trigger. $\endgroup$ – Mehness Dec 7 '16 at 16:39
  • $\begingroup$ A credit derivative is a contract with a credit specific trigger. I specifically stated that a bond futures contract has credit risk. $\endgroup$ – Dom Dec 25 '16 at 5:05
  • $\begingroup$ Happy New Year. I disagree with the first sentence in your comment, but this may just be semantics, since you do acknowledge the credit risk. I would 100% class a CVA on an IRS as a classic credit rate hybrid (and therefore both a credit and interest rate derivative). But there's no term sheet credit trigger here (unless in 4th Trigger CCDS form). Anything with credit risk is a credit derivative, but this may be a (necessary) perspective for any hybrid trader, particularly when the documentation itself is sparse, uncommoditised, risks are not explicitly referenced etc. $\endgroup$ – Mehness Jan 2 '17 at 9:01
  • $\begingroup$ If the CVA was priced and traded as a separate contract it would have a term sheet with a credit trigger which would state that on a bankruptcy event the ITM party is paid the swap value. That is a credit derivative. $\endgroup$ – Dom Jan 3 '17 at 9:54
  • $\begingroup$ see my comment re 4th trigger CCDS. Bankruptcy/FTP/Restruc are not sufficient, you also need failure to perform under swap obligations (the '4th trigger'). OK, we will have to agree to disagree, since your definition of credit derivative is narrowly dictated by the presence of contractual terms, whereas mine is more general, i.e. - do you need credit sensitive hedges. What is the instrument's actual risk, versus merely its legal drafting. I don't think we will be able to bridge that gap, but thanks for the debate. $\endgroup$ – Mehness Jan 3 '17 at 12:28
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Good lord - sovereign debt crisis anyone? 2010? Sorry it's a hybrid like any bond, not just corporates bonds, that way of looking at the world is as aged as thinking that banks can always fund at LIBOR, it is emphatically BOTH a credit derivative and an interest rate derivative. To ignore credit risk on a european government bond and to use use words such as 'highly rated government bond' is completely to ignore the aftermath of the credit crunch. After all, why do european govvies trade at differing asset swap spreads if not for differing credit quality between eg Greece / Italy / Germany. Why do these spreads loosely follow sovereign CDS spreads (albeit on a mean reverting basis given liquidity factors influencing bond CDS basis). Why does the ECB impose varying haircuts on EGBs posted as collateral if not for reasons of credit quality? All bonds have credit risk, doesn't matter if they're issued by a government, or a corporate, or a bank. Sovereigns default, they have non-zero credit spreads. Please let's not repeat the mistakes of the past!

All that having been said, as the OP is forced to make a choice, I do agree that most banks will rightly classify and trade these in their rates pod. I just wanted to be clear that this is owing to being forced to classify, than for the fact that there is no credit risk in the product. Anyone who has traded through the sovereign debt crisis might feel this distinction.

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