ommodity futures contracts have frequently allowed multiple varieties of a C commodity to be delivered . In some cases, there are objective measures of the differences in the varieties deliverable. In other cases, the exchange sets up a formula for value in delivery. These formulas may penalize some varieties of the commodity and make one variety cheapest to deliver.
The Chicago Board of Trade Treasury Bond futures contract allows for delivery of bonds with at least 15 years to call and 15 years to maturity. The value of a bond in delivery is determined by a rule which is called factor pricing (to be explained in detail below). Under factor pricing the cheapest deliverable bond will depend upon bond coupon level, maturity, and upon the term structure of interest rates. This article analyzes the impact of these factors upon the cheapest deliverable bond.
First, this article shows that the cheapest deliverable bond for the CBT Treasury Bond futures contract will be the bond with the smallest ratio of bond price divided by adjustment factor. This cheapest bond will have the lowest cost per unit of value in delivery.
Secondly, this article shows that higher coupon bonds will be better to deliver if bond yields to maturity are 8% or higher, as long as coupon effects are positive (i.e., higher coupon bonds have higher yields). Since positive coupon effects are widely observed in practice, higher coupon bonds will generally be better to deliver. This conclusion is far stronger than , who showed for a neutral coupon effect that lower coupon bonds will be better to deliver, and suggested that a positive coupon will tend to introduce a bias towards higher coupon bonds. The current results show that this bias is an overwhelming effect.
Thirdly, the article examines the impact of bond maturity upon the cheapest deliverable bond. The article considers zero-coupon, discount, par, and premium bonds. For discount bonds, the longest maturity bond is shown to be best to deliver, as long as the bond coupon is 8% or greater and the yield curve is flat or rising. In other cases, short, intermediate, or long maturity bonds may be best to deliver. These results contrast sharply with , who claimed that the long-