ORC CONNECT – Fixed Income Overview Trading Fixed Income on Orc

FIXED INCOME OVERVIEW TRADING FIXED INCOME ON ORC

Orc Software now provides connectivity to the largest cash fixed income venues

in North America – eSpeed and BrokerTec. The addition of these market

connections presents opportunities to market our products to a new customer

segment. Customers have the ability to trade cash, futures, and options

instruments against one another in many new relative value and hedging plays.

Matching algorithms in cash fixed income markets are different from those of the

derivatives exchanges. The trade matches take longer to perform and can

appear to be very latent to customer unfamiliar with cash bond trading.

Customers should be aware of this market characteristic and its potential effects

on trading algorithms.

The relevant markets, trading opportunities, and terminology are explained

below. Details of available instruments for each platform are contained in the

accompanying spreadsheet.

ORC CONNECT – FIXED INCOME OVERVIEW

Trading Fixed Income on Orc

Markets:

eSpeed

The electronic cash fixed income platform owned and operated by BGC partners (formerly

Cantor). On eSpeed, customers can trade on-the-run, and some off-the-run cash US

Treasuries, as well as cash Canadian Treasuries. eSpeed also lists what they term basis (cash

vs. futures) and swap (cash yield curve spread) instruments. The eSpeed matching engine and

hosting facilities are located in New Jersey.

BrokerTec

The electronic cash fixed income platform owned and operated by ICAP in New Jersey. The

BrokerTec platform that Orc and its competitors support lists cash US Treasuries and Canadian

Treasuries. BrokerTec also lists the ‘when issued’ or ‘WI’ treasuries (next in line for the

auction), but doesn’t list any off-the-run bonds on combos.

ELX

The electronic futures exchange is owned by BGC partners and conglomeration of banks and

trading firms. The exchange was created to compete with CBOT (now CME Group) and its

suite of treasury futures products. ELX lists futures on US Treasury notes and bonds. The ELX

matching engine utilizes eSpeed’s trading technology, and is located right next to the Speed

engine in New Jersey.

CME Group

CME lists futures on US Treasuries and options on those same futures. CME also lists yield

curve swaps (spreads) and interest rate swaps of various terms (fixed vs. floating), as well as

futures and options on other short term interest rate products.

Montreal Exchange

The Montreal Exchanges lists futures on Canadian Treasury notes and bonds, as well as

options on the 10 Treasury futures contract. In addition to the longer term treasury futures, MX

lists short-term interest rate futures, and options on those futures contracts.

Eurex

Eurex lists futures contracts on German government issued bonds, and options on those futures

contracts. These products are tradable in the US and may be of interest to customers looking

for international spreading plays.

NYSE LIFFE

NYSE LIFFE lists futures on UK government issued bonds (Gilts), and options on those futures

contracts. These products are tradable in the US and may be of interest to customers looking

for international spreading plays.

ORC CONNECT – FIXED INCOME OVERVIEW

Trading Fixed Income on Orc

Trades of Interest:

Basis Trade – Cash vs. Futures

A basis trade, as explained below, is a cash vs. futures relative value play. This trade can be

executed in a number of different ways. For US Treasuries, the cash leg can be executed on

either eSpeed or BrokerTec, while the futures leg can be done on wither ELX or CME. CME still

has much more liquidity the ELX, but the relative proximity of the ELX matching engine to both

eSpeed and BrokerTec (New Jersey) plays well for our customers who won’t have to deal with

the distance-related latency between Chicago (CME) and New Jersey.

The Canadian Basis trade can be executed between the Montreal Exchange and either eSpeed

or BrokerTec, both of whom list cash Canadian treasuries.

Yield curve swap (spread) – Cash vs. Cash or Futures vs. Futures

A Yield curve swap is also a relative value play whereby trades take a view on the steepness of

the yield curve and take a long position on one part of the yield curve and short position on

another part of the curve. These traders believe the yields between these instruments will either

widen (steeper curve) or narrow (flatter curve), and attempt to profit from the move.

Inter-market arbitrage – Cash vs. Cash or Futures vs. Futures

This is a relative value play whereby traders attempt to profit from short-term pricing

discrepancies on similar instruments trading on different exchanges.

Inter-product arbitrage – Cash vs. Cash or Futures vs. Futures

This is a relative value play whereby traders attempt to profit from perceived value

discrepancies on similar term instruments of different constituencies. For instance, a trader

might believe that the Two Year US Treasury note is out of its expected value range with the

Two Year Canadian Treasury note, based on interest rate regimes and currency conversion

rates.

Calendar Spread – Futures vs. Futures

This is a relative value play were traders believe two futures contracts with the same underling

and different contract maturities are trading out of expected value range with one another.

Hedging – Cash, Futures, Options

Orc’s interest rate options traders now have two hedging options for their options positions.

They can hedge with the futures trade on any number of exchanges, or hedge with a cash

position.

ORC CONNECT – FIXED INCOME OVERVIEW

Trading Fixed Income on Orc

Glossary:

Yield Curve

A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but

differing maturity dates. The most frequently reported yield curve compares the three-

month, two-year, five-year and 30-year U.S. Treasury debt. This yield curve is used as a

benchmark for other debt in the market, such as mortgage rates or bank lending rates. The

curve is also used to predict changes in economic output and growth.

Futures Basis

The theoretical difference between a cash (underlying) asset and its corresponding futures

contract(s) is called the futures basis. This basis consists mainly of a time value of money

component., but may also contain or be affected by a cost to carry or store a particular asset in

the case of physical commodities.

Basis Trade

A Basis Trade is a cash vs. futures relative value play that can be made with any underlying

asset. It is a particularly popular trade with interest rate and other financial products where

storage costs are not an issue. Whenever an actual futures price implies some difference

between the theoretical futures price and the cash price, an arbitrage opportunity may be

present because the actual and theoretical futures prices will revert as maturity approaches.

ORC CONNECT – FIXED INCOME OVERVIEW

Trading Fixed Income on Orc

Swap

A Swap is a transaction where participants trade the return on one instrument for the return on

another. The original swap was executed so that one party paid a fixed interest rate and

received a floating interest rate, and the other party paid/received the opposite.

In the case of our fixed income connections, a swap is basically just a spread of two different

bonds – a long position in one and a short position in the other. Traders take a view and

attempt to profit on a steepening or flattening of the yield curve.

Treasury Bond

A treasury bond is a sovereign government debt instrument that has a fixed interest rate and an

original term to maturity of greater than 10 years.

Treasury Note

A treasury note is a sovereign government debt instrument that has a fixed interest rate and an

original term to maturity between 1 and 10 years.

Treasury Bill

A treasury bill is a sovereign government debt instrument that has a term to maturity of less than

1 year.

Additional Information on the Fixed Income Market and

Trading Strategies:

CME Understanding U.S. Treasury Futures Reference Guide (PDF)

Yield Curve Shifts Create Trading Opportunities Strategy Paper (PDF)

Enhanced Interest Rate Options Trading (Webinar)

Yield curve spread Canada-U.S. (PDF)

Yield curve spread 2-year/10-year Government of Canada (PDF)

Cash and carry trade (PDF)

Credit spread: 2-year Government of Canada bond futures / BAX 2-year strip (PDF)

Yield curve spread 5-year/30-year Government of Canada (PDF)