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FRM Part I · FRM Exam Part I · Futures Markets

A Treasury bond futures contract allows the short position to deliver any of several eligible bonds. Which statement best describes how the conversion factor is used in this delivery process?

The conversion factor scales the futures settlement price when computing the invoice amount, so that delivered bonds with different coupons and maturities are comparable to a standard bond yielding the contract's notional rate. Accrued interest is added separately, and the factor does not determine delivery timing.

  1. AIt adjusts the invoice price so that bonds with different coupons and maturities are put on a comparable basis to a standard bond yielding the contract's notional rateCorrect
  2. BIt is added to the futures price to compensate the long for accrued interest on the delivered bond
  3. CIt determines which day within the delivery month the short must deliver
  4. DIt converts the futures price into a yield quote for the cheapest-to-deliver bond

Explanation

The invoice price equals the settlement futures price times the conversion factor plus accrued interest. The conversion factor standardizes bonds of differing coupon and maturity relative to a notional-coupon bond. It does not set delivery timing or serve as a yield conversion.

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