Chapter Twenty Three
ANSWERS TO QUESTIONS
1. Everything else being equal, investors prefer a higher coupon to a lower one,
and a higher yield to maturity to a lower one. Correction factors, in theory,
make all bonds equally attractive by making some bonds “count more” in the
delivery process with T bond futures.
2. The bond equivalent yield adjusts for the fact that there are 365 days (not 360)
in a year and the T-bill investment requires initial payment of the discounted
price, not the par value.
3. The yield curve does not always experience a parallel shift. There is likely to
be tracking error if a short-term portfolio is hedged using a long-term
instrument.
4. A callable bond is not equivalent to a non-callable bond. If there is a
preference for one investment over another, the two will not sell for the same
price. The T-bond futures contract is based on bonds that are non-callable in
the near term.
5. The manager of a money market portfolio, the corporate treasurer who was
holding an unusually large cash balance, or the investment officer who
anticipated a purchase of money market securities in the near future and
wanted to lock in the current rate.
6. Interest rates might move in your favor, in which case you will have an
opportunity loss. Also, a lower duration usually results in a lower portfolio
yield, and you will usually incur transactions costs.
7. The need to hedge long-term rates is probably more important, although this
depends on your perspective.
8. The hedge would be less than ideal for the same reasons mentioned in problem
3.
9. Using the logic of Table 23-3, the fewer bonds you would have to deliver (for a
given bond price), the better to you.
10. This is false. The product of interest sensitive asset dollars and their duration
must equal the product of interest sensitive liability dollars and their duration.
11. Settlement prices differ for the various delivery months because of anticipation
of changing interest rates and because of the structure of the yield curve.
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Chapter Twenty Three
ANSWERS TO PROBLEMS
1. Following the procedure on page 515 of the book, a price of 93.33 gives a
discount of 6.67%. One fourth of this (for 90 days) is 1.6675%. The price you
are promising to pay is then
$1,000,000
 $983,598.50
1.016675
2. A change of one basis point = $25.
6 basis points
$25
x 4 contracts x
 $600
contract
bp
3. Duration equals the maturity.
4. a. From equation 23-2,
$10000 = $9800 - discount amount
discount amount = $200
$200  $10,000 x
88
x ask discount
360
ask discount = .0818 = 8.18%
b. Bond
equivalent
yield
Discount amount
365
$200 365
x

x
 8.46%
Discount price
Days to maturity
$9800 88
5. Using the Convfact file, the factor is 1.1019.
1.1019 x $100,000 x 0.92 = $101,374.80
6. Student response.
7. Using the Convfact file, the factor is 1.1926.
8. Using the Convfact file, the factor is 1.3555.
2
=
Chapter Twenty Three
9. The conversion factor is 0.8410. Interest per six month period is 6.5% x 0.5 x
$100,000 = $3,125.00. Halfway through the six-month period the accrued
interest will be $1,562.50. The invoice price is then
x
x
+
0.9200
$100,000
0.8410
$77,372.00
1,562.50
$78,934.50
futures settlement price
contract size
correction factor
10. Changing the bond for delivery has two effects on the invoice price: accrued
interest changes and the conversion factor changes. The conversion factor
would be 1.3467. The accrued interest increases to 9% x .5 x .5 x $100,000 =
$2,250.00. The invoice price increases to $126,146.40.
11. Use equation 23-7 to determine the number of contracts:
HR  CFctd x
Pb x D b
Pf x D f
# Contracts = CFctd x
Pb x D b Portfolio value
x
Pf x D f
$100,000
We do not have sufficient information to determine unambiguously the
conversion factor for the cheapest to deliver bond, but we can do everything
else:
# Contracts = CFctd x
0.928 x 5.55 $2,737,460
x
 CFctd x 14.837
0.905 x 10.5 $100,000
12. Using the Convfact file, the factor is 1.4078.
13. Student response. You would buy T-bill futures to lock in the current interest
rate.
14. Student response. You would buy T-bond futures.
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