Fixed Income - Cheapest to deliver (CTD)

CFA Level III
#1

Does it mean bond future short seller has the obligation to buy back the physical bond via cheapest to deliver method?

Below from Kaplan

Cheapest to deliver (CTD) is a very descriptive term for a bond that the counterparty in the short position can deliver to satisfy the obligation of the futures contract. For example, many different bonds can be used to satisfy a CBOT 30-year Treasury bond futures contract. Furthermore, the short position has some choice with respect to the time of delivery.

#2

The short is delivering the bonds and being paid by the long. The short doesn’t buy back anything.

#3

Thanks, so short seller needs to find the bond to deliver when future mature and he can find the cheapest one?

Or the clearninghouse will do it automatically?

#4

The clearinghouse will do it if they’re short; the short seller will do it if the clearinghouse is long.

#5

Got it, thanks. I thought clearinghouse will do both side.

#6

Nope: it’s an option owned by the short.

#7

CFAI material 2014 (i know i should move on…) indicates that the conversion factor is “based on” the price that a deliverable bond would sell for at the beginning of the delivery month it were to yield 6%. What does it mean in practice? How is it really computed? Thanks for your help.

#8

The theoretical underlying on a US T-Bond futures contract is a 20-year, 6% coupon, option-free T-Bond. Any T-Bond with 15 years or more to maturity or first call can be delivered.

The conversion factor for a given deliverable bond is computed based on the actual market price of that bond and the theoretical market price of the theoretical underlying bond:

CF = Price of theoretical bond / price of deliverable bond

#9

Thanks! Yes, makes total sense. In the material 2014 it says that the discussion focusses on "30 year bond futures contract’. Then it continues “the underlying instrument for the Treasury bond futures contract is … a hypothetical 30-year, 6 percent coupon bond. … The CBOT allows the seller to deliver any Treasury bond that has at least 15 years to maturity…”. So 30 vs 15 while you mention 20 vs 15. Is it that my material is outdated? Honestly, as i failed cfa 3 last year, i found it hard to resume with the new material as i made some marks on the pages of the 2014 one. I still haven’t taken a decision on how i should proceed to take into account the changes in the program yet… not really sure what to do. So i have been procrastinating on this so far… If you have a hint to share it would be much appreciated!! Thank you!

#10

Now that they’re issuing 30-year T-Bonds again, the theoretical underlying may have changed to a 30-year bond. When they weren’t issuing 30-year bonds I grew accustomed to the 20-year theoretical.

#11

Thank you! If anyone has a hint on how to retake an exam, if it’s ok to reuse last year’s material especially for level iii 2014 vs 2015 as there have not been many changes… First time i don’t pass the exam so i am a bit confused about how to proceed.