Board of Trade Gearing Up for Municipal Bond Index Futures
CHICAGO (AP) _ The Chicago Board of Trade is gearing up for trading in a new futures contract on municipal bonds, a contract that could reduce the borrowing costs of 40,000 public agencies ranging from the smallest school district to New York City.
Such public agencies borrowed $130 billion through bond issues in 1984. But for the dealers who purchased them and, in turn, sold them to investors, there was a risk involved.
And to compensate for that risk, they were forced to charge a little higher interest, said Ron Curvin, vice president of the municipal dealer department of Chemical Bank in New York.
The risk involves changes in interest rates, he said.
If interest rates rise between the time a dealer buys a bond from the issuer and sells it to an investor, the bond loses value and the dealer suffers a loss.
But the dealer could earn a profit to offset the loss by selling an equivalent amount of futures contracts when he buys the bond, and subsequently buying back the futures contract at a lower price at the same time he sells the actual bond to an investor.
″This will give us the ability to hedge our position during periods of rising interest rates,″ said Curvin.
Ted Palatucci, vice president and manager of national municipal bond trading and underwriting at Merrill Lynch Capital Markets Group in New York, said, ″One of the intriguing things about the contract is it may very well help us take interest rate risk out of the issuer’s situation.″
Dealers previously would cover their risk by charging the issuing agency a higher interest rate, but if the municipal bond index futures contract is a success, the dealers will be able to reduce the interest rate, albeit by only a fraction of a percentage point.
But a fraction of a percentage point might amount to a million dollars on a major bond issue, Palatucci said.
Municipal bond dealers currently can hedge contracts in the bonds by selling Treasury bond futures, which also are traded at the Board of Trade, but Curvin said Treasury issues and municipal bond issues frequently move in different directions. Depending on supply and demand and the quality of the borrowers, the yield in one might increase while the other might fall.
″The problem is that it’s an imperfect hedge,″ said Palatucci. ″And it’s not unusual for the market maker to get whipsawed.″
The new index will be maintained and published by the Bond Buyer, a 94- year-old publication serving the municipal bond industry.
Richard Tierney, president of the trade paper, said he originally thought of an index for municipal bonds in 1981. But developing an index that would determine an average interest rate being charged on more than 1,000 different bond issues was a formidable task, he said.
The index to be used will be based on a ″basket″ of 40 individual bonds and will be revised twice a month.
Trading in the index is to start June 11, and attendance at a recent seminar introducing the contract was surprisingly large.
Curvin said the contract could get off to a slow start because interest rates currently are in a declining trend, which reduces the incentive to hedge.
Nevertheless, he said, the municipal bond industry is anxious to have the product.
″There’s nobody that doesn’t benefit,″ he said.
″Municipal dealers will be able to carry more inventory. Municipal buyers will be more comfortable with a position they can hedge. And ultimately it will make for a more perfect market.
″That will carry through to the issuers in the form of lower interest rates,″ Curvin said.
Here are some price trends in major commodity markets this past week:
Grain and soybean futures prices were steady to lower on the Chicago Board of Trade.
Wheat for delivery in July settled Friday at $3.15 a bushel, which compared with $3.161/4 a bushel the previous Friday; July corn settled at $2.741/2 a bushel, unchanged from a week earlier; July oats slipped to $1.503/4 a bushel from $1.521/2 ; and July soybeans fell to $5.67 a bushel from $5.681/4 .
Livestock prices were lower and frozen pork bellies were higher on the Chicago Mercantile Exchange.
Live cattle for delivery in June settled Friday at 60.10 cents a pound, down from 63.57 cents the previous Friday; August feeder cattle fell to 68.07 cents a pound from 69.60 cents; June live hogs fell to 47.95 cents a pound from 48.90 cents; and July frozen pork bellies advanced to 67.75 cents a pound from 66.75 cents.
Gold was slightly higher and silver and copper were slightly lower on the Commodity Exchange in New York.
Gold for delivery in June settled Friday at $316.20 a troy ounce, which compared with $314.80 a week earlier; June silver settled Friday at $6.156 a troy ounce, down from $6.159; and copper fell to 60.25 cents a pound, down from 63.50 cents.