Aug 29

Conversion factor for Treasury bond futures contract – 7 min screencast

by David Harper, CFA, FRM, CIPM

The short position in a US Treasury bond futures contract can select among many different eligible (maturity > 15 years) bonds for delivery. This is by design; the Fed and Treasury do want to see a “run on the issue” if only one bond can be delivered. The conversion factor puts the eligible bonds on a level playing field, making the short almost (but not quite) indifferent to which bond is delivered.

In this way, the short selects a bond for delivery. The bonds have different maturities and coupons. And so different prices. But the long pays the settlement price multiplied by the conversion factor; this is what makes the short almost indifferent to which bond is delivered: bonds with high coupons will have higher conversion factors, the short will receive more for them but they cost more (have higher prices). Bonds with lower conversion factors imply lower a receipt for the short, but they cost more to purchase.