The Thrifty Journey of the Cheapest-to-Deliver Bond: A Closer Look into its Exponential Rise and Market Impact

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The Cheapest to Deliver Bond

Introduction

A cheapest to deliver bond (CTD bond) refers to the deliverable bond with the lowest cost in a futures contract. It is established as the benchmark against which other bonds, in the same product category and delivery month, are measured.

Understanding Cheapest to Deliver Bond

In a futures contract, the seller needs to provide a specific bond to the buyer upon the completion of the contract. The bond that is delivered is known as the cheapest to deliver bond. Its selection is crucial as it affects the overall profitability of the contract.

Factors Determining CTD Bond

The determination of the cheapest to deliver bond depends on several factors:

• Price: The bond's market price relative to other deliverable bonds is an essential factor. Generally, the cheapest bond is the one with the closest price to the contract's price.
• Coupon Rate: The coupon rate of the bond impacts its overall value. A bond with a higher coupon rate would often be cheaper to deliver.
• Maturity: Maturity date is also a crucial factor. Long-term bonds usually have higher yields compared to short-term bonds, making them more desirable as a cheapest to deliver bond.
• Liquidity: The liquidity of a bond – how easily it can be bought or sold – influences its suitability to be the cheapest to deliver bond.

Importance in Pricing

The cheapest to deliver bond holds significant importance in pricing and trading of futures contracts. Its price, influenced by factors such as interest rates and investor demand, becomes a reference point for determining the fair value of the other bonds associated with the contract.

Conclusion

In the world of futures contracts, the cheapest to deliver bond ensures consistency and fairness across similar products by establishing a baseline benchmark. It is crucial to carefully analyze the various factors, such as price, coupon rate, maturity, and liquidity, to identify the cheapest to deliver bond accurately.

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