Conversion factor of the bond

CFA Level II
#1

Hi,

Can someone explain in simple terms the conversion factor of the bond. I don’t understand the concept.

Thanks.

#2

The underlying on a T-Bond futures contract is $100,000 par of a theoretical, 20-year, 6% coupon, noncallable Treasury Bond. Unfortunately, no such bond exists. In its stead, the short is allowed to deliver the equivalent market value in any Treasury bond with at least 15 years to maturity. Because (probably) none of those bonds will trade at the same market price as the theoretical bond, a conversion factor is calculated for each deliverable bond, equal to its market price per $100,000 par divided by the (theoretical) market price of the theoretical bond per $100,000 par. That conversion factor is used to determine the par value of that deliverable bond that is required.

For example, if Bond A has a market price that is 80% of the market price of the theoretical bond, then its conversion factor will be 0.8000, and short would have to deliver $100,000 ÷ 0.8000 = $125,000 par of Bond A to satisfy a T-Bond futures contract.

2 Likes
#3

Thanks magician. How many hours did you study for CFA level II? Must be 3000 +

You are simply awesome!

#4

My pleasure.

Before the exam: probably 400 hours.

Since the exam: probably 2,000 hours or more.

You’re too kind.

Here’s another thread on the subject: http://www.analystforum.com/forums/cfa-forums/cfa-level-i-forum/91330426

#5

Wa! 2,000 hours+

CFA Institute or Schweser should hire you!

I think they are seriously lack of man power to answer candidate’s question now…

#6

Schweser has.

I fly to Philly tomorrow.

#7

Wow, cool!

This forum is lucky. We get free professional service:)

#8

I was looking for some explanations on CTD and conversion factor and came across this discussion.

I wonder why 20-year, 6% coupon, noncallable Treasury Bond does not exist?

#9

Because the Treasury tries to issue T-Bonds at close to market rates (which aren’t remotely close to 6% today), and because even if they issue a 20-year T-Bond today, tomorrow it’s only a 19-year, 364-day T-Bond, not a 20-year T-Bond.

#10

Sounds very logical. Thank you

#11

You’re welcome.