how do you know what the yield for a particular bond?

[brut]

sorry if this is a total newbie question, but looking a the prices of bond futures, say 5-year t-note, where do you find out what %age the t-note pays? is this not integral to the price ?

if notes pay diffeerrnt rates depending on when they were issued, how do you know when the t-note was issued?

thanks

 

[MrGecko]

There are a couple of things you might need to know if you want to calculate the "fair value" of a t-note future:

** the underlying t-note can be delivered at any time during the delivery month

** there are a variety of 5's that are available for delivery, although it is usually the Cheapest to Deliver, the bond for which Quoted price - (settlement x conversion factor) is the least.

But, if you know the delivery date, and you assume the CTD bond is the bond underlying the future, then the futures price is the present value of the spot price minus the cash flows to the holder - like any other asset with a known income stream.

 

[brut]

sorry, i'm totally confused. a t-note is issued with a corresponding coupon, is a knowledge of this %age not integral to the price of the bond? so instead of talking about a 2-year t-nopte, should there not be something that refers to the %age repayment that is paid to the owner of the bond?

 

[brut]

sorry, i'm totally confused. a t-note is issued with a corresponding coupon, is a knowledge of this %age not integral to the price of the bond? so instead of talking about a 2-year t-nopte, should there not be something that refers to the %age repayment that is paid to the owner of the bond?

 

[MrGecko]

You find out the coupon rate of the bond underlying the future by:

finding all the bonds that are deliverable under the contract (w/ maturities from about 6 years to 10). Then find out their conversion factors from the CBOT, or calculate it. Then do Futures Price x Conversion factor for all the notes, and the one which is smallest is the CDT.

Then, to find the futures price, take the quoted ("clean") price of that particular note, and add on the accrued interest to get the Cash ("dirty") price.

Once you've done that, find the present value of the remaining coupon payments the holder of the bond will recieve, take these off the cash price, and use this as the Spot price to calculate the Futures price.

then, use the date of delivery to calculate the accrued interest at delivery, and discount the futures price for this.

Lastly, divide by the conversion factor, and you've got the "fair" futures price on the CDT t-note.

**** I have no idea why they made it so complicated. I had to use Hull *****

 

[brut]

ok, thanks. it seems strange that the coupon rate attached to a bond is not made clear? is this not like selling a car without revealing what make or color it is?

 

[MrGecko]

If you are trading the bond, then the coupon will be readily known, along with the yield, duration, convexity and so on...

the problem is that the future is not on one particular bond, it is on any on a basket of fungible bonds (in terms of delivery, anyway).

 

[brut]

understood, thanks