Cheapest To Deliver

Cheapest to deliver, or CTD, is defined as the least expensive way for a contract seller to fulfill a contract to deliver units of a specific security. In some cases, the grade of underlying stock, bond, or commodity is not specified in the contract or the contract specifically states that the seller may choose among a selection of different grades of the stock in question in order to maximize profit or minimize losses when the securities are due for delivery. The practical investor will fulfill the contract with the cheapest to deliver bond in order to maximize his or her own profits. Typically, a conversion factor must be employed when determining which stocks are cheapest to deliver; this cheapest to deliver conversion factor is intended to serve as an equalizing force for available grades of the stock in question.

The cheapest to deliver conversion factor is set by the Chicago Board of Trade. In general, the conversion factor is set at a level that is expected to negate any major financial advantages of a particular transaction; however, certain advantages are possible when choosing between various options. Typically, the cheapest to deliver bond price is calculated by determining the lowest cost option; cost is determined by taking the CTD Treasury bond purchase price and adding any accrued interest due. The equation most commonly used for calculating cheapest to deliver bond pricing is derived by subtracting the futures bond price from the current quoted bond price and multiplying the result by the conversion factor for the security, as in:

• CTD = Current bond price – futures bond price * conversion factor

CTD Treasury bond calculations are often based on the implied repo rate, or the money realizable from purchasing an asset and then delivering it on the futures market; the higher the implied repo rate, the cheaper that asset is to deliver. This is due to the differential between the initial purchasing cost and the higher futures market value; the rate of return encompasses both the coupon value of the asset and the increase or decrease in value realized when the futures contract comes due and the assets are delivered.
Tim Ord
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