[ 2009 FRM Sample Exam ] Market risk measurement and management Q10

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10. John H., a portfolio manager, is shorting a US Treasury bond futures contract and has decided to deliver. The quoted futures price is USD 95.5. There are four deliverable bonds:

Bond A is quoted at USD 125.69 and has a conversion factor of 1.1979.

Bond B is quoted at USD 90.31 and has a conversion factor of 0.8109.

Bond C is quoted at USD 87.6 and has a conversion factor of 0.8325.

Bond D is quoted at USD 128.56 and has a conversion factor of 1.2249.

Which is the cheapest?to?deliver bond?

A. Bond A

B. Bond B

C. Bond C

D. Bond D

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Correct answer is Cfficeffice" />

The cheapest?to?deliver bond is the one for which

Quoted price ? (quoted futures price * conversion factor)

is least.

The delivery values of the four bonds are:

       Bond A: 125.69 ? (95.5 * 1.1979) = 11.29

       Bond B: 90.31 ? (95.5 * 0.8109) =12.86

       Bond C: 87.6 ? (95.5 * 0.8325) = 8.10

       Bond D: 128.56 ? (95.5 * 1.2249) = 11.58

Bond C is the smallest and is the cheapest?to?deliver.

Reference: John Hull, Options, Futures, and Other Derivatives, 5th ed. (ffice:smarttags" />New York: Prentice Hall, 2003), Chapter 5.

Type of Question: Market Risk