Apart from their usefulness as hedging vehicles, Treasury bond futures may offer significant return advantages. When Treasury bond futures are undervalued relative to the market for cash Treasury bonds, investment managers may be able to profit by substituting futures for cash bonds. Simulated results indicate that futures substitution strategies can add 1.51 per cent annual incremental return without materially changing the risk profile of a Treasury bond portfolio.
Because the Treasury bond contract prices a specific security, called the cheapest-to-deliver Treasury bond, the contract is most appropriately substituted for that bond or a very closely related issue. It is possible to substitute futures for other Treasury bonds, but care must be taken, as the results will depend not only on the degree to which futures are undervalued, but also on changing yield spreads between the target bond and the cheapest-to-deliver bond.