Anyone else would have expected the wording “the cheapest to deliver bond is priced…with duration…”?? Instead they speak of futures contract. So why applying the conversion factor in the solution?
When short delivers the actual bond to the investor of a long futures contract , sometimes there could be many different alternative securities that could be delivered , as specified in the terms of the contract. Usually short is allowed to deliver an available bond of their choosing that meets the specs. This is called CTD , and it has a conversion factor. I am sure you know all this from previous lvl s ?
OK, just to make it clear: 2 different wordings - first one like in the original text: “the futures contract it would use is priced at €130,000 and has a duration of 9.35. Assume that the conversion factor for the futures contract is 1.06” “the cheapest to deliver bond to the futures contract it would use is priced at €130,000 and has a duration of 9.35. Assume that the conversion factor for the futures contract is 1.06” first one i wouldn’t use the conversion factor in my calculation, while in the second one i would…but CFAI also does in first wording.
What is the futures contract on? – it is on a bond. what is the bond that would be delivered – the cheapest to deliver bond. so in option 1) even though they do not specifically mention it – that is how it is… not sure if a futures contract on a bond to be delivered is on a fixed bond. It is upto the “seller” of the bond to decide which bond he would deliver - and more often than not it would be the CTD bond.
They have mixed up the terms . The CTD bond has a conversion factor , while the futures contract may have a number of alternative bonds that COULD be delivered , each having its own conversion factor . They used the CTD bonds conversion factor and just short-formed it into the “conversion factor for the futures contract” . The actual CTD to be delivered by the short is only known the day before delivery ( depending on the richness of the alternatives) , so you certainly do not know the conversion factor or indeed the price of the bond, when you buy the futures contract.
i’m pretty familiar with the concept of CTD…so no worries with that…BUT when a price for the future is given why applying the conversion factor??? when CTD price is given I would apply…if you like i would also apply when futures price is given and i would physically hedge with CTD in the cash market…
Yes, that was my understandint too: Bond Fut Price=CTD price/con. factor
I agree with IRS-Trader solution says: DCTD = the duration of the cheapest-to-deliver bond = 9.35 PCTD = the price of the cheapest-to-deliver bond = €130,000 they can use conversion factor in that case, but the problem say it is futures price and duration
mik82 Wrote: ------------------------------------------------------- > Yes, that was my understandint too: Bond Fut Price=CTD price/con. factor So, conversion factor is incorporated in futures price ?