EFPs allow a trader to easily transfer their exposure between Treasury futures and cash Treasuries without leg risk. A trader is exposed to leg risk when two legs of a transaction (e.g., buying Treasury futures and selling cash Treasuries) are executed as separate trades, since the price associated with the second leg may change in the time after the first leg is executed. Since an EFP involves the simultaneous trading of both legs, leg risk is eliminated.
This makes EFPs particularly useful for establishing a Treasury basis position, which consists of offsetting positions in Treasury futures and cash Treasuries. Securities dealers and other market participants use basis positions to hedge their basis risk, while arbitrageurs and proprietary traders may trade the basis to generate profit.
EFPs also allow market participants to utilize the liquidity of Treasury futures to establish interest rate risk exposure quickly and efficiently before shifting that exposure to cash Treasury positions. For example, a fixed income asset manager that receives a large inflow of funds can initially buy Treasury futures to establish their desired interest rate exposure and then use EFPs to gradually exchange those futures positions for cash Treasury positions. This serves as an alternative to initially buying a large volume of cash Treasuries, which may be operationally challenging and lead to unfavorable prices. By using EFPs, asset managers are still able to establish their desired level of interest rate exposure once funds are received while optimizing the timing of their cash Treasury purchases.
EFPs may also be used by market participants to exchange Treasury futures positions for cash positions in other securities that are highly correlated with cash Treasuries, such as corporate bonds and mortgage-backed securities, depending on their needs.