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Thursday, May 11, 2023

Euro Bund: Product Analysis

تم إعداد هذا المنشور من قبل سنشري للاستشارات

Euro Bund: Product Analysis
Euro Bund: Product Analysis

*Trading in the financial market carries risk and can result in loss of capital.
*Statistics or Past performance is no guarantee of future results

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The product and investment ideas do not consider the risk profile and financial position of the recipient and may not be suitable for everyone. Trading in financial markets and the use of leverage involves a significant risk of loss, which can exceed deposits. Please read the complete Disclaimer carefully

Risk and Assumptions:

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The testing environment has not considered transactions or any other costs.
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Returns may vary if there is any error in executing the trades.
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Past performance is not indicative of and does not guarantee future results. Trading in markets may involve a loss of capital. Please read the complete disclaimer carefully.
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Any further change in the underlying macros apart from the ones mentioned below may result in significant deviations affecting the performance.
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Holding costs mentioned below are based on the ones currently available over the platform. Holding cost is subject to change impacting the trade either negatively or more positively.
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Where an investment is denominated in a currency other than the investor's currency, changes in rates of exchange may have an adverse effect on the value, price of, or income derived from the investment

Product Summary

Based on statistical analysis, if the 10-year German yield increases by 50 basis points, the Euro Bund price is forecasted to be €130.37. On the other hand, if the 10-year German yield declines by 50 basis points, the Euro Bund’s price is anticipated to be €143.30.

When the 10-year German yield decreases by 50 basis points, the potential gain on a portfolio with 3x leverage is 23.43% p.a. adjusted for the holding cost received. Meanwhile, if the 10-year German yield increases by 50 basis points, it could result in a potential loss of 4.99% p.a. after considering the holding cost received.

When the 10-year German yield decreases by 50 basis points, the potential gain on a portfolio with no leverage is 7.81% p.a. adjusted for the holding cost received. Meanwhile, if the 10-year German yield increases by 50 basis points, it could result in a potential loss of 1.66% p.a. after considering the holding cost received.

Euro Bund – Product Details

The Euro Bund is a treasury bond issued by the German federal government with a time-to-maturity ranging between 8.5 to 10.5 years. It’s a sovereign debt instrument that helps to finance government projects and expenditures, such as infrastructure, insurance markets, and pensions. Euro Bund Futures is available on both the Century and TradeUltra platforms. Additionally, the investor can potentially earn a holding cost of 2.89% on the Euro Bund Cash Contract on the TradeUltra platform.

Potential Holding Cost Calculations

Potential Holding Cost Receipt on Trade Ultra platform 2.89%
Assumed Leverage 3x
Total Potential holding cost received 8.66%
* Holding Costs are subject to change based on market fluctuations.

A portfolio with 3x leverage can potentially earn a holding cost of 8.66% p.a. on a Euro Bund cash contract.

ECB – The Path Ahead

The European Central Bank (ECB) initiated a smaller interest rate hike of 25 basis points in May 2023 – bringing its deposit rate to a 15-year high at 3.25%. While headline inflation has declined to 7% from its double-digit peak, core inflation remains stubbornly close to a record high. As a result, ECB policymakers have signaled additional policy tightening at the upcoming meetings to tamp down sticky price pressures. As of now, money markets are ascribing a 90% probability of another 25-basis point interest rate hike in June’23 and are expecting the ECB’s deposit rate to peak at 3.75%. This view was strengthened further after consumer inflation expectations for the next 12 months in the eurozone ticked up to 5% in May’23 from 4.6% in Feb’23. Even the three-year ahead expectations advanced to 2.9% from 2.4% - stubbornly above the central bank’s 2% target.

Euro Bund: Price Analysis

The ECB hiked interest rates by 25 basis points in May 2023. The hawkish remarks made by ECB policymakers since then indicate that further policy tightening can be expected during the upcoming meetings. Currently, the 10-year German yield is around 2.240%. The table below demonstrates the impact on German Bund prices under two scenarios – a 50-basis point increase in the yield and another in the event of a 50-basis point decrease in the yield.

Euro Bund Scenario Analysis (With 3x Leverage)

Scenario 1: Yield increases by 50 bps Particulars No. of Units Current Price Amount Invested Leverage Position Size Price when yield increases by 50 bps Profit Potential when yield increases by 50 bps
20135 € 136.58 $1,000,000 3 $3,000,000 € 130.37 $-136,461
Potential Holding Cost Received $ 86,599
Total $ -49,862
-4.99%
Scenario 2: Yield decreases by 50 bps Particulars No. of Units Current Price Amount Invested Leverage Position Size Price when yield decreases by 50 bps Profit Potential when yield decreases by 50 bps
20135 € 136.58 $1,000,000 3 $3,000,000 € 143.30 $ 147,679
Potential Holding Cost Received $ 86,599
Total $ 234,278
23.43%

EUR/USD = 1.0909

When the 10-year German yield decreases by 50 basis points, the potential gain on a portfolio with 3x leverage* is 23.43% p.a. adjusted for the holding cost received. Meanwhile, if the 10-year German yield increases by 50 basis points, it could result in a potential loss of 4.99% p.a. after considering the holding cost received.

*Trading in leveraged Over-The-Counter (OTC) Derivative products including Contracts for Difference (CFDs) and spot foreign exchange contracts involves a significant risk of loss which can exceed deposits and may not be suitable for all investors.

Euro Bund Scenario Analysis (With No Leverage)

Scenario 1: Yield increases by 50 bps Particulars No. of Units Current Price Amount Invested Leverage Position Size Price when yield increases by 50 bps Profit Potential when yield increases by 50 bps
6712 € 136.58 $1,000,000 - $3,000,000 € 130.37 $-45,487
Potential Holding Cost Received $28,866
Total $-16,621
-1.66%
Scenario 2: Yield decreases by 50 bps Particulars No. of Units Current Price Amount Invested Leverage Position Size Price when yield decreases by 50 bps Profit Potential when yield decreases by 50 bps
6712 € 136.58 $1,000,000 - $3,000,000 € 143.30 $49,227
Potential Holding Cost Received $28,866
Total $78,093
7.81%

EUR/USD = 1.0909

When the 10-year German yield decreases by 50 basis points, the potential gain on a portfolio with no leverage is 7.81% p.a. adjusted for the holding cost received. Meanwhile, if the 10-year German yield increases by 50 basis points, it could result in a potential loss of 1.66% p.a. after considering the holding cost received

Euro Bund Price Estimation using Regression Analysis

Regression analysis is a useful tool to assess the strength of relationships between different variables and for modelling how these relationships will evolve in the future. The model below is used to forecast how changes in the 10-year German yield will influence the Euro Bund prices.

The regression equation over a 20-year time-period is as follows:

Y = -12.936 X + 165.812

Change in the 10-Year German Yield 10-year German Yield Estimated Bund Price
If the yield increases by 50 bps 2.740 € 130.37
If the yield decreases by 50 bps 1.740 € 143.30

Source: Bloomberg
Date: 11th May 2023

There is an inverse relationship between the Euro Bund and the 10-year German yield. Thus, a 50-basis point increase in the 10-year German treasury yield would likely cause a drop in the Euro Bund’s price to €130.37. On the other hand, a 50-basis point decrease in the 10-year German treasury yield would likely cause the Euro Bund price to increase to €143.30.

Simple Linear Regression between the Euro Bund and 10-year German yield

Point to Note

It is essential to remember that not all yields move in tandem with the Euro deposit rate. Empirical analysis shows that movement in the Euro deposit rate is largely influenced by changes in the short-term interest rates. By contrast, the impact of changes in long-term interest rates is less dominant. This is apparent from the chart below which reveals longer-term bonds like the 10-year German Treasury bond are impacted less by the Euro deposit rate. Nevertheless, changes in the deposit rate are likely to impact all spectrums of the yield curve.

ECB Deposit Rate near a 30-year peak

Risks and Assumptions for Back-tested trading strategies
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The risks and assumptions listed here are not intended to be an exhaustive summary of all the risks and assumptions involved.
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The strategy might suffer from look-ahead bias which occurs due to the use of information or data in a study or simulation that would not have been known or available during the period being analyzed. This can lead to inaccurate results in the study or simulation.
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Future price movements may not be exactly the same as the historical price movements and this could lead to variation in performance.
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Testing can sometimes lead to over-optimization. This is a condition where performance results are tuned so high to the past they are no longer as accurate in the future.
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The model assumes no slippages in trading. Slippage refers to the difference between the expected price of a trade and the price at which the trade is actually executed.
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Drawdowns in actual trading can be higher than the tested system and losses could be significant in the event of leverage.
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Unforeseen events can lead to variation in performance from the tested trading strategy.
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The tested result has been computed with price feeds available from Bloomberg.
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The testing environment has not considered transaction or any other costs.
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Trading indicators used for the purpose of testing has been provided by Bloomberg.
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The strategy might suffer from data mining fallacy, selection bias and backfill bias.

Data Source: Bloomberg
Data & Prices as of 11/05/2023

Arun Leslie John
Chief Market Analyst

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