We have looked at Bond futures and have seen what they are and how they can be used. Thinking about the 10 Year US Treasury Note futures contract trading on the CME we can see that the following US Treasury bond (semi-annual, act/act) falls under the definition of a deliverable bond and is the current CTD:

2.50% 15/11/2032 priced at 108-03 for value 2 August 2022 (NB: remember US treasuries are priced in fractions and so 03 stands for 3/32nds)

This contract has a notional value of USD 100,000

a) We have said this bond is a deliverable security. Explain what this means and why it is necessary. (Max: 150 words) (20%)

b) This bond has a conversion factor of 0.7342. Explain what this is, how it is calculated and how it is used in the futures market. (Max: 100 words) (10%)

c) An investor holds a long position of $10,000,000 nominal of these bonds and would like to use the futures contract to hedge this position. How many contracts will they need to trade to manage the risk? Remember to say whether the investor needs to buy or sell the contracts. How efficient do you think this hedge will be? (Max: 100 words) (20%)

d) Assuming a repo rate of 0.25% for 30 days what would be the forward price of this bond on the first deliverable date of the September contract, and then convert this to an equivalent bond future price. (30%)

e) On 1 September 2022, the first deliverable date, the investor decides to deliver these CTD bonds against the position they have taken in the bond futures. Using the position size you calculated in part (c) and then the bond future price you calculated in part (d), calculate the settlement proceeds on this trade.