CBOT may alter Muni Bond Index to refine related futures contract.

CHICAGO - The Chicago Board of Trade proposed several changes to The Bond Buyer Municipal Bond Index that may make the exchange's associated futures futtract more useful to investors.

Investors and analysis welcomed the changes, but most said they would use the new contract no more than the old one.

The proposed changes would add noncallable and deep discount bonds to the 40-bond index, which now is comprised of only callable debt. The board also proposed resetting the index's coefficient, used to average the bond prices within the index.

Patricia J. Mosley, a senior product manager at the exchange, said that the Commodities Futures Trading Commission must approve the proposals, which were passed by the CBOT's board of directors on May 17. Approval from the trading commission could take two to four months, Mosley said.

The changes will cause the futures contract to better reflect the market as a whole, Mosley said.

Investors agreed. "It will make it a little bit more responsive and should over the longer haul track the government market a little more closely," Joseph Deane, portfolio manager at Shearson Asset Management, said.

But Deane said he only uses the contract to short the market when he expects rates to rise. "It's only a defensive vehicle for us. That won't change," he said.

One analyst agreed that the changes would "make the contract more representative of the market as whole, which obviously includes noncallable bonds," But the effect on users "will be minimal," he said.

Given the complex nature of the index, tinkering with terms will not transform the contract into a straight-forward trading vehicle, according to Christopher Dillon, municipal market strategist at J.P. Morgan Securities.

"The contract itself has so many factors that influence it. These are beneficial changes, but the contract just has too many quirks to be an easy trade," Dillon said.

If approved by the trading commission, the revisions would be effective June 30, 1995. Mosley said. The September 1995 contract would be the first to be affected by the revisions.

The proposed revisions were discussed at an educational seminar on municipal futures sponsored by the CBOT in Chicago late Wednesday.

Mosley said that adding noncallable and deep discount bonds to the index would make the index more "reflective" of the municipal bond market.

Adding such bonds would also change the index's duration, which could have a harmful effect on a firm's hedging strategy, said one person at the seminar.

"We probably won't use it," he said.

But Sylvie Bouriaux, advisory economist for the CBOT, responded that market participants would have advantage warning of the change so they could adjust their positions.

Adding noncallable bonds would lengthen the duration of the contract and increase its appreciation potential when the market rallies, analysts said. The value of callable bonds, which make up the majority of municipal issuance, tends to rise less than the value of noncallables when the market rallies.

Resetting the coefficient, to a value of one, would increase absolute volatility and temporarily restore the price/ yield relationship of the contract, Bouriaux said. Since the futures contract on the index began trading in 1985, the coefficient has declined to a current 0.8293 from one, she said.

The decline in the coefficient has "dragged down" the price spread between the municipal bond features contract and the Treasury bond contract. Bouriaux said.

"A lot of people trading in the market are not happy," she said.

But the coefficient would continue to decline after being reset and eventully would have to be reset again, analysts said.

Changing the coefficient and revising the criteria for including bonds in the index have been the subject of debate among market participants for several years.

Some market participants have cited the low volatility of the contract as a reason for using the CBOT's more liquid U.S. Treasury bond futures contract as a hedge for their municipal portfolios.

Bouriaux said that the CBOT hopes the proposed revisions will help increase volume in the contract.

Trading volume for the futures contract has picked up from last year. Exchange statistics show an average daily volume of 6,858 contracts during the first five months of this year, compared to 4,142 contracts for the same time period last year.

Many portfolio managers turned to the futures contract as an alternative to the cash market during the market's big declines this year when liquidity was scarce.

The contract hit a record daily volume of 20,104 contracts on March 2 and an open interest record of 37,070 contracts on April 6. Open interest stood at 30,795 contracts at the end of May, compared to 20,804 contracts at the end of May 1993.

A task force comprised of market participants was responsible for drafting the proposed changes that the CBOT board passed last month and another recent revision to the contract, Mosley said.

In November, the board introduced serial expirations months for its Municipal Bond Index options on the futures contract. Previously, the quarterly expirations of December, March, June, and September were listed for the contract. CBOT officials said that the addition of serial expirations will give market participants more flexibility.

The options on the futures contract have dropped in volume since last year. From January to May, the average daily volume was 143 contracts, compared to 397 contracts for the same period in 1993. Open interest at the end of May was 1,762 contracts, compared to 16,897 contracts at the end of May 1993.

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