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What is the right formula to calculate cheapest to deliver bond out of following options:
1) (F×CF) – S ; or
2) (S-F) × CF
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To calculate the cheapest-to-deliver (CTD) bond, you need to find the bond with the lowest adjusted cost of delivery. The adjusted cost of delivery takes into consideration the bond’s price, conversion factor, and futures price.
Both the formulas will lead to the same CTD. The first formula is a profit formula & so CTD via this formula is the one which is the highest profit to the short.
The second formula is a loss formula & so CTD via this formula is the one which is the lowest loss to the short.