A fixed-income derivative which represents a physically-settled futures contract linked to a pool of Treasury bonds with remaining maturities of more than 15 years. Furthermore, the underlying bonds must be noncallable within 15 years at least. Futures contracts are quoted, as their underlying bonds, on 32nd, i.e., in percent plus thirty-seconds. For example, for a T-bond futures with a notional amount of US 1 million, and based on a quotation of 98-04, the price of the contract is
p= USD 1 million x (98 + 4/32)/100 = USD 981,250
The long position in such a futures contract would make a profit (incur a lost) if yields go down (up). For example, if yields increase, edging the quoted price up, say, to 98-16. In this case, the new price of the underlying bond would be USD 98,500. The profit is, therefore
USD 985,000- USD 981,250= USD 3,750.
As t-bond futures contracts are physically settled, a conversion factor is typically used to ensure interchangeability between different bonds. This factor helps equalize the net cost of delivering various bonds.
