1981, futures trading has coexisted on two closely related financial A instruments: 91-day U.S. Treasury bills (T-bills) and 90-day domestic certificates of deposit (CDs). This article investigates arbitraging these two futures markets with tandem T-bill and CD spreads.
A tandem T-bill and CD spread comprises four futures positions, consisting of a purchase (sale) of a T-bill spread and a matching sale (purchase) of a CD spread.
"Buying" a spread means buying a near-term futures contract and selling a deferred futures contract. In a "sale" of a spread, the positions are reversed. Equivalently, tandem T-bill and CD spreads may be looked at as a near-term T-billlCD spread offset by a deferred T-billlCD spread.
Because it comprises two long and two short interest rate positions, tandem T-bill and CD spreads should be largely immune to general changes in the level of interest rates. Also, the price of the tandem spread does not depend on the general term structure of interest rates or on the general amount by which CD interest rates exceed T-bill interest rates, but on only the difference in this amount for two different delivery months. Profits in tandem T-bill and CD spreads depend on relative changes in the term structure of interest rates in the T-bill and CD markets.
Consider the hypothesis that the basis of an interest rate spread tends toward equality for T-bill and CD futures; that is, the price of the tandem spreads tends toward zero. For example, if the December 1981 T-bill futures rate is 50 basis points higher than the March 1982 T-bill futures rate, this hypothesis infers that the December 1981 CD futures rate ought to be 50 basis points higher than the March 1982 CD futures rate as well.