# Bond Futures question

Hello all, I am working through CFAI book 6 and am struggling with bond futures pricing. In example 4 on page 105, the solution to C divides the bond futures price by 1.0372. I have no idea where this number comes from! Somebody please tell me it is a typo! Thanks.

That is the conversion factor which is given in part C.

^ Just to add to this, it would probably be helpful to explain why a conversion factor is used in the first place. The actual contract specifications on a Treasury bond futures contract call for delivery of one U.S. Treasury bonding having the face value at matrurity of \$100,000 (or muliple there of). I don’t have the book in front of me, so I am not sure if they go into detail on this. Since these contracts are physically delivered instead of cash-settled, actual delivery is based on a 6% coupon. However, due to factors in supply and demand, on any given delivery day (which is 3/3 to 3/31 for March 2008 30 yr bond futures), there are going to be a listing of long positions and a listing of short positions at different coupon rates. In order to equate the settlement price in the contract with the bond that is actually being delivered, the conversion factor is applied to calculate the “actual settlement price” on the invoice. Due to this calculation in the delivery process, market participants will track both the price movements and the availablility of the issue that is “cheapest to deliver” from the perspective of the short bond holder. They will also track the price movements and availablity of other issues that are alternatives. At any particular time, either at expiration or before, a treasury futures contract price reflects the prices of the deliverable grade issues that the market participants EXPECT will play a role in the delivery process.

Lisa Marie Wrote: ------------------------------------------------------- > ^ Just to add to this, it would probably be > helpful to explain why a conversion factor is used > in the first place. > > The actual contract specifications on a Treasury > bond futures contract call for delivery of one > U.S. Treasury bonding having the face value at > matrurity of \$100,000 (or muliple there of). I > don’t have the book in front of me, so I am not > sure if they go into detail on this. > > Since these contracts are physically delivered > instead of cash-settled, actual delivery is based > on a 6% coupon. However, due to factors in supply > and demand, on any given delivery day (which is > 3/3 to 3/31 for March 2008 30 yr bond futures), > there are going to be a listing of long positions > and a listing of short positions at different > coupon rates. > No - the futures contract doesn’t make you long or short any bond. It just measn you are long or short a bond futures which might ultimately be delivery settled. > In order to equate the settlement price in the > contract with the bond that is actually being > delivered, the conversion factor is applied to > calculate the “actual settlement price” on the > invoice. > > Due to this calculation in the delivery process, > market participants will track both the price > movements and the availablility of the issue that > is “cheapest to deliver” from the perspective of > the short bond holder. They will also track the > price movements and availablity of other issues > that are alternatives. At any particular time, > either at expiration or before, a treasury futures > contract price reflects the prices of the > deliverable grade issues that the market > participants EXPECT will play a role in the > delivery process.

Lisa Marie Wrote: ------------------------------------------------------- > ^ Just to add to this, it would probably be > helpful to explain why a conversion factor is used > in the first place. > > The actual contract specifications on a Treasury > bond futures contract call for delivery of one > U.S. Treasury bonding having the face value at > matrurity of \$100,000 (or muliple there of). I > don’t have the book in front of me, so I am not > sure if they go into detail on this. > > Since these contracts are physically delivered > instead of cash-settled, actual delivery is based > on a 6% coupon. However, due to factors in supply > and demand, on any given delivery day (which is > 3/3 to 3/31 for March 2008 30 yr bond futures), > there are going to be a listing of long positions > and a listing of short positions at different > coupon rates. > No - the futures contract doesn’t make you long or short any bond. It just measn you are long or short a bond futures which might ultimately be delivery settled. Sorry ~ I did not mean to imply that a futures contract would make the holder “long or short any bond”. I was referring to the fact that, during the delivery month, each clearing firm (FCM), beginning with the first intention day through to the last intention day, must present a listing of all long contracts (both House and customer accounts) expiring that month, in addition to a listing of any short contracts for which a Notice of Intent to Deliver was presented by the short contract holder. The exchange clearing house will then match the short intents with the long positions starting with the oldest trade date for the long. Therefore, if a long contract holder does not wish to take the chance of having to take physical delivery (which is just basically a book entry in the Fed Reserve wire system), of an expiring contract he must close out his position prior to the first intention day. Depending on which short contracts have declared intent, the “deliverable supply” can be an assortment of short contracts based on bonds with different coupon rates. Therefore, the contract settlement price will use a conversion factor based on the coupon rate in the underlying asset, which is that particular treasury bond identified by the CUSIP number on the issue.

^The deliverable supply is the variety of coupons and maturities available for the short to deliver on the contract, identified by a CUSIP. The short will usually perform an analysis to determine which issue is “cheapest to deliver”. Even though the conversion factor is only used in the invoice during delivery, the theoretical futures contract price will reflect the price of the issue(s) that market players think will play a role in the delivery process.

Yep. Bloomberg will just give you the CTD bond. Of course, you can look at various interest rate changes and make some really good guesses about what the CTD bond will be.