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FRM Part I · FRM Exam Part I · Interest Rate Futures

A trader holds a short position in a Treasury bond futures contract. The contract allows delivery of any of several bonds with different coupons and maturities. Which statement about the short's delivery rights is correct?

The short position chooses which eligible bond to deliver, and rationally picks the cheapest-to-deliver bond, the one minimizing the cost of purchase relative to the invoice amount received. The long cannot select the bond, and the exchange does not assign it randomly.

  1. AThe short can choose which eligible bond to deliver, and will tend to deliver the cheapest-to-deliver bondCorrect
  2. BThe long chooses which eligible bond is delivered, and will select the one with the highest coupon
  3. CThe exchange assigns the bond to be delivered at random from the eligible list
  4. DThe short must deliver the most recently issued bond on the eligible list

Explanation

The short position holds the delivery options, including which bond to deliver. Because the invoice price is based on the conversion factor, the short selects the bond that costs least relative to what is received, the cheapest-to-deliver. The long has no say in the choice.

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