Interest Rate Futures - Quoted vs Settlement price

[msi273]

Hi all,

In Chapter 6 of the "Financial Markets and Products" the cheapest-to-deliver-bond is calculated
using a "quoted price" and a "settlement price".

What is exactly the difference of these two? For my understanding a "settlement price" is simply "quoted" somewhere ...

regards,
M

 

[ShaktiRathore]

Among a set of Bonds that a dealer can deliver for a futures contract is the CTD or cheapest to deliver Bond. If CF is the conversion factor that dealer would use to get settlement price for the bond, then settlement price is the price at which the trade is settled which is Quoted price/CF. Quoted price is the market price at which the bond is quoted at ,while settlement price is price at which the price of the bond is settled between the dealer and the counter-party and trade is executed. i think u would get the difference here b/w the quoted and settlement price
thanks

 

[David Harper CFA FRM]

In Hull generally, "settlement price" is a special case (type) of quote: typically the closing (end of day) price quote; or sometimes it is the "cash market price."

In the specific case of T-bond futures, they are both quoted prices. But:

• the settlement price is the quoted price of the futures contract (the derivative); i.e., the quote but a futures price quote
• The quoted price refers to the quote price of the CTD bond purchased for delivery; i.e., a quote but the quoted spot price of the underlying commodity (a qualifying T-bond)

To remind about the transaction to which this refers: This is a futures contract where the underlying asset happens to be a Treasury bond. A futures contract often (typically) settles early, before expiration, in cash. However, rather than a cash settlement, the terminology above refers to the atypical settlement by delivery at contract expiration, such that: the short receives (per her/his promise to sell) an "invoice amount" (i.e., based on the settlement price of the futures) from the long (who promised to buy per the futures contract) by delivering a (cheapest-to-deliver) the cash bond (based on its quoted price).

 

[msi273]

okay, thank you.

 

[Sabit Rahimov]

Hi all,

In Chapter 6 of the "Financial Markets and Products" the cheapest-to-deliver-bond is calculated
using a "quoted price" and a "settlement price".

What is exactly the difference of these two? For my understanding a "settlement price" is simply "quoted" somewhere ...

regards,
M

Hi
İdea behind Cheapest to delivery bond is as follows:
Let say you are in short position in the interest rate futures and at maturity you must deliver treasury bond with maturity more than 15 years and non callable within this maturity. Generally, short party interested to deliver cheapest to delivery bond in terms of the cost.

At maturity of the futures, for the purpose of delivering T bond, you buy bond from the market and pay for that in the amount Quoted price + Accrued int. (that is the cash price of the T-bond)

Consequently, what you receive from the interest rate futures for the t-bond is cash price of the futures (that is settlement price x conversion factor for that bond + accrued interest)

Numerically, it is expressed as follows:

Your cost: cash price of t bond = quoted price of the bond + accrued interest
Your proceeds: cash price of the futures = settlement price x conversion factor + accrued interest
Cost - proceeds = (quoted price of the bond + accrued interest)-(settlement price x conversion factor + accrued interest) = quoted price of the bond - (settlement price x conversion factor of the bond)
For each of the t bond that expires more than 15 years, you need some calculation as indicated above and the bond with the lowest value is cheapest to delivery bond.

Hope it will be helpful!
Good luck.

 

[Jhoony]

Hi

I searched the internet and also the BT website for a deeper explanation of CTD bond in contrast to yields and the 6% YTM used to get the CF. I thing I am stuck with my logical inconsistency I cannot solve on my own. I completely understand that:

1. When yields on bonds are below 6% (e.g. 3%) the CTD bond will be one with the shorter maturity as it is less heavily discounted, thus CF will be higher and my proceeds from receiving the settlement price will be higher than for longer maturity bond, ceteris paribus.

2. When yields on bonds are above 6% (e.g. 8%) the CTD will be the one with the longer maturity. In this case the »bonus« doesn,t come from the CF, but from the lower PV of the quoted bond I want to buy and deliver (my cash outflow)

The thing that is unclear to me is the coupon effect. It seems that CTD depends also on the settlement price of the futures and market yields have an effect on the futures settlement price. But I don’t really know why.

3. Why for yields > 6%, the low coupon bonds are preferred? This is true when settlement price is at a high premium, when it is below par (e.g. 80 dollars) this is not true, at least in my excel

4. Why for yields < 6% the higher coupon bonds are preferred? This is true when settlement price is at high discount (80 dollars), but not consistent when the settlement price is at premium (120 dollars).

I tried to turn around the data in excel, but it seems I have a logical inconsistency I keep bumping into. Thanks.

 

[Delo]

Referring to this topic " When yields on bonds are below 6% (e.g. 3%) the CTD bond...". Where is the "6%" number coming from? Is this rule of thumb?

 

[ShaktiRathore]

hi,
6% is the ytm the yield which is used to discount future cash flow of the bond to get the price of the bond. So when yield get low pv of future cash flows increases(now discounting at lower yield say 3% instead of higher 6% yield)and thus increasing the price of the bond or CF from selling the bond , in sense cheapest to deliver should be this bond with falling yield with short duration. Whereas when yield get high pv of future cash flows decreases(now discounting at higher yield say 8% instead of lower 6% yield)and thus decreasing the price of the bond or CF from buying the bond, in sense cheapest to deliver should be this bond with falling yield with higher maturity.
6% is nothing but the benchmark yield of the bond it could be anything x% and we are comparing the yield changes effect w.r.t this benchmark on bonds value.
thanks