Learning objectives: Explain and calculate a US Treasury bond futures contract conversion factor. Calculate the cost of delivering a bond into a Treasury bond futures contract. Describe the impact of the level and shape of the yield curve on the cheapest-to-deliver Treasury bond decision. Calculate the theoretical futures price for a Treasury bond futures contract.
Questions:
720.1. The Treasury bond futures contract allows the party with the short position to choose to deliver any bond that has a maturity between 15 and 25 years. Assume a certain bond that is valid for delivery matures in 15 years and two months (15.1667 years) and has a coupon rate of 9.0% payable semi-annually. Which is nearest the bond's conversion factor (CF)?
a. 0.8530
b. 1.0420
c. 1.1380
d. 1.2940
720.2. The counterparty with the short position in a Treasury bond futures contract has decided to deliver and is trying to decide between the four bonds displayed below; e.g. the quoted price of bond #4 is $129.41 and its conversion factor (CF) is 1.290.
If the future contract's settlement price is $99.00, then which bond is cheapest to deliver (CTD)?
a. Bond #1
b. Bond #2
c. Bond #3
d. Bond #4
720.3. [This is tedious and difficult. Inspired by the final LO above and Hull's EOC Question 6.11] Today it is December 31, 2018. The cheapest-to-deliver bond in an August 2018 Treasury bond futures contract is a 9.0% coupon bond, and delivery is expected to be made on August 28, 2018. Coupon payments on the bond are made on April 2 and October 2 each year. In this case, therefore, as of settlement today (December 31, 2018) there were 90 days since the last coupon and there will be 92 days until the next coupon. Delivery will be in 240 days (and subsequent coupon date 35 days after delivery, or 275 days from today). The term structure is flat, and the rate of interest with semiannual compounding is 3.0% per annum. The conversion factor for the bond is 1.380. The current quoted bond price (for this bond which is assumed to be the cheapest to deliver) is $115.00. What is the quoted futures price for the contract?
a. $73.59
b. $80.70
c. $94.75
d. $106.44
Answers here:
Questions:
720.1. The Treasury bond futures contract allows the party with the short position to choose to deliver any bond that has a maturity between 15 and 25 years. Assume a certain bond that is valid for delivery matures in 15 years and two months (15.1667 years) and has a coupon rate of 9.0% payable semi-annually. Which is nearest the bond's conversion factor (CF)?
a. 0.8530
b. 1.0420
c. 1.1380
d. 1.2940
720.2. The counterparty with the short position in a Treasury bond futures contract has decided to deliver and is trying to decide between the four bonds displayed below; e.g. the quoted price of bond #4 is $129.41 and its conversion factor (CF) is 1.290.
If the future contract's settlement price is $99.00, then which bond is cheapest to deliver (CTD)?
a. Bond #1
b. Bond #2
c. Bond #3
d. Bond #4
720.3. [This is tedious and difficult. Inspired by the final LO above and Hull's EOC Question 6.11] Today it is December 31, 2018. The cheapest-to-deliver bond in an August 2018 Treasury bond futures contract is a 9.0% coupon bond, and delivery is expected to be made on August 28, 2018. Coupon payments on the bond are made on April 2 and October 2 each year. In this case, therefore, as of settlement today (December 31, 2018) there were 90 days since the last coupon and there will be 92 days until the next coupon. Delivery will be in 240 days (and subsequent coupon date 35 days after delivery, or 275 days from today). The term structure is flat, and the rate of interest with semiannual compounding is 3.0% per annum. The conversion factor for the bond is 1.380. The current quoted bond price (for this bond which is assumed to be the cheapest to deliver) is $115.00. What is the quoted futures price for the contract?
a. $73.59
b. $80.70
c. $94.75
d. $106.44
Answers here:
In our revised learning XLS, I've tried to compact this into a user-friendly exhibit. Below shows the answer to Hull's EOC Problem 6.11. A key aspect is the timeline. Also, I explicate the cost of carry model (lower-right); in my opinion, this is the easiest way to mentally process this price calculation. Thanks!
