Pricing Interest Rate/Treasury Bond Futures
The pricing of Treasury bond futures is performed in the same formulaic manner as presented earlier in the futures section.
Note that the spot price includes any accrued interest for the bond.
The Treasury bond future price must be divided by the conversion factor.
Because the futures contract seller is allowed to deliver from a range of bonds at expiration to fulfill the contract, a conversion factor must be applied to the futures price.
Treasury bond pricing is based on the "cheapest to deliver" (CTD) bond as this would be the most rational decision for the futures contract seller.
- Step 1: Price Treasury Bond Future
Treasury Bond Futures Price: f0(T) = [S0 - PV(CF)](1+r)T
Treasury Bond Futures Price (alternative formula): f0(T) = S0(1+r)T - FV(CF)
CF = Coupon payment during the remaining life of the contract term
S0 = Full bond price, including accrued interest
Step 2: Apply the Conversion Factor
Treasury Bond Price = Futures Price of the CTD/Conversion factor
Note: expect the exam to provide the CTD bond and the conversion factor. The test taker may be required to price a futures contract, given that data.
Either of the formulas from step 1 could be divided by the conversion factor; either would yield the same result.
- CFA Level 2: Derivatives Part 1 – Introduction
- What are Forward Contracts?
- Equity Forward Contracts
- Fixed Income Forward Contracts
- Currency Forward Contracts
- Forward Rate Agreements (FRA)
- Credit Risk and Forward Contracts
- Introduction to Futures Contracts
- Futures: Convergence of Spot and Futures Prices at Expiration
- Futures Prices vs. Forward Prices
- Contago and Backwardation
- Pricing Stock Index Futures
- Pricing Interest Rate/Treasury Bond Futures
- Pricing Currency Futures
- Eurodollar Futures