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Introduction of European bond futures market- Part 1 and 2

Prof. Dr. Martin Hellmich (May 2013)

Akademische Programme Berufsbegleitende Programme Seminare Executive Education Firmenprogramme & Services Forschung Internationale Beratung

Part 1


Some questions . . .
 How is the forward value of a bond calculated?  What is the conversion factor?  What do I get on expiration of the bond future?  What is the nature of the options that the seller of the future enjoys?  What is the cheapest to deliver (CTD) bond?  How is the CTD identified?  Under what circumstances will the CTD change?

 Forward pricing  Contract Specification and Conversion Factors  Futures Expiration  Cheapest to Deliver  Gross and Net Basis

Forward prices
 Forward prices are driven by the concept of “cash and carry”  Say that an institution asks for delivery of a bond in three months time but wants to fix a price today  The price of this bond for forward delivery will be driven by the cost of hedging the transaction


Cash and carry
 Buy the cash bond  Hold it for a certain time period  Pay repo interest on the financing of the position  Earn coupon interest from the bond  Deliver the bond against the short forward position

Clean cash price + Repo expense – Coupon income = The forward price of the bond

Theoretical forward price (OTC)

Forward clean price = Cash clean price + Net cost of carry

N    FA  SA  FP = SP + (SA + SP)  R  360  
Forward Clean Cash Price Clean Price Repo Interest Paid Net Coupon Income Earned

Cost of carry

FP = Futures clean price FA = Accrued interest at forward settlement SP = Spot clean price

SA = Accrued interest at spot settlement R = Funding rate (in decimal) N = Holding period


Forward prices

Clean Price Cash Bond

If coupon income is greater than…...

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