What is a BAX Contract?
A BAX contract is a short-term investment instrument that tracks the nominal value of a Canadian bankers' acceptance (BA). The specific BA behind the contract has a nominal value of C$1 million and a maturity of three months. They were first launched in 1988 by the Montreal Exchange and has since gained traction from futures traders. Today, investors can still find the contracts trading on the Montreal Exchange. Another name for a BAX contract is a "bankers' acceptance contract."
Understanding BAX Contracts
A BAX contract is a great way for a company or investor to hedge against rising interest rates. They are often considered less expensive, more liquid and flexible than similar over-the-counter products and forward rate agreements (FRA). The contract is traded on an index basis and settled in cash in March, June, September, and December. These dates align with delivery dates of Eurodollar futures contracts traded on the Chicago Mercantile Exchange (CME), which also creates a potential arbitrage opportunity between the BAX and the Eurodollar futures markets.
Prices are quoted by subtracting the annualized yield of a three-month Canadian bankers' acceptance from 100. For example, September contracts offered at 95.20 on the floor of the exchange would imply a 4.80% (100 - 95.2) annual yield for the note.
At any point in time, there are eight contracts with distinct delivery dates listed for trading on the Montreal Exchange. Each contract is identified by its delivery month: the first contract expires the soonest, while the last closes on a later date. Similar to other futures markets, the first BAX is more widely followed than newer contracts expiring at a later date and therefore more liquid. This is consistent with a narrower spread between bid and ask prices than remaining contracts.
Hedging with BAX Contracts
BAX contracts are often used for removing or reducing interest rate exposure in the money market at a given point in time. The holders can hedge against an anticipated rate hike by selling BAX contracts when the market prepares for an uncertain stretch. Once the situation stabilizes, the investors can close out the position for profits on the BAX position that offset losses on other assets.
Furthermore, BAX contracts act as a great compliment to a traditional forward rate agreement for hedging exposure to interest rate movement. The investors can limit chunks of risk by purchasing a forward rate agreement and hedge against the other portion by selling BAX contracts.