TRADING CASE B03
Forward contracts on zero-coupon bonds
LEARNING OBJECTIVE
Trace forward-contract cash flows and determine no-arbitrage forward prices for bonds.
KEY CONCEPTS
Forward pricing | Zero-cost entry | Delivery | Discounting
HOW THE CASE WORKS
You trade four bonds and two forward contracts. Forward 1 is a contract to exchange the Year-2 zero at the end of Year 1. Forward 2 exchanges the Year-3 zero at the end of Year 2.
BOND PAYMENTS
| Instrument | Year 1 | Year 2 | Year 3 |
|---|---|---|---|
| 10% coupon bond | 10 | 10 | 110 |
| 1-year zero | 100 | 0 | 0 |
| 2-year zero | 0 | 100 | 0 |
| 3-year zero | 0 | 0 | 100 |
INTEREST RATES
Known annual rates are 4%, 10%, and 16% in Years 1-3. Cash earns these rates and borrowing costs the same rates.
TRADING RULES
- No cash changes hands when you enter a forward. The quoted price is paid at delivery.
- If you buy a forward, you pay the forward price and receive the bond.
- If you sell a forward, you deliver the bond and receive the forward price.
- You may sell bonds and forwards short, but you must meet all payments and deliveries.
AFTER TRADING CLOSES
Interest is applied to your closing cash.
Bond payments and any forward delivery due that year are completed.
Trading then moves to the next year; after Year 3, all positions become cash.
PERFORMANCE: Trading bonus (grade cash) per trial = 0.0001 x closing market cash. Positive wealth adds grade cash; negative wealth subtracts it. Results accumulate across independent trials.