- 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
- 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 Futures Price (alternative formula): f0(T) = S0(1+r)T – FV(CF)
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.