Consider a three-year R1 par Treasury bond with a 7.5% annual yield and 8% semiannual coupon. Its price is R1.0132. A futures contract calling for delivery of this bond only expires in one year. The one-year risk-free rate is 7%.
1 Determine the future value in one year of the coupons on this bond. Assume a reinvestment rate of 3.75% per six-month period.
2 Determine the appropriate futures price.
3 Now suppose the bond is one of many deliverable bonds. The contract specification calls for the use of a conversion factor to determine the price paid for a given deliverable bond. Suppose the bond described here has a conversion factor of 1.0372. Now determine the appropriate futures price.
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