Hi there,
I have been trying to understand the formula of the bond futures more specifically why we include the AI at time zero and why we subtract it at the time of the contract expiration.
I am calculating the bond futures price based on the formula that I have memorized, but when I think about it, i just don’t get the logic behind this it.
Can someone please help me?
Bonds are priced including accrued interest. When you enter into the long position in a forward contract on a bond you don’t (yet) own the bond, so you’re not entitled to the accrued interest; therefore, you don’t have to pay for it, and it’s subtracted from the spot price.
When the contract expires, you’ll get the bond, whose price will include accrued interest; therefore, it’s added at expiration.