Conversion factor - Financial definition
Concise definition of the term conversion factor
Multiplicator used to neutralize differences in the characteristics in terms of coupon rate and maturity of the deliverable bonds for a futures contract.
Comprehensive definition of the term conversion factor
Usage of the conversion factor
The conversion factor is a key element in hedge calculations and, more generally, in the analysis of all market operations including bonds and futures.
When a futures contract is held until maturity, the delivery price of a bond for physical settlement of the future is obtained by multiplying the bond's price with its conversion factor.
Calculation
Mathematically, the conversion factor is the bond's clean price, using the future contract's delivery date as value date and the future's nominal coupon rate as the bond's yield.
Example:
Bond:
Name: Bundesobligation (Ticker Bloomberg ticker: DBR)
Coupon: 4.000%
Maturity: 04-JAN-2018
Future:
BUND JUNE 2009
Nominal coupon: 6.000%
Delivery date: 10-JUN-2009
As mentioned above, we will calculate the bond's clean price using the future's delivery date as value date, and its coupon rate as the bond's yield.
Bond cash flow table
Bond:
Name: Bundesobligation (Ticker Bloomberg ticker: DBR)
Coupon: 4.000%
Maturity: 04-JAN-2018
Future:
BUND JUNE 2009
Nominal coupon: 6.000%
Delivery date: 10-JUN-2009
As mentioned above, we will calculate the bond's clean price using the future's delivery date as value date, and its coupon rate as the bond's yield.
Bond cash flow table
| Cash flow date | Discount period | Cash flow amount | Cash flow present value | ||||||||||||||||||||||||||||||
| 04-JAN-2010 | 0.56986 | 4.000 | 3.8694 | ||||||||||||||||||||||||||||||
| 04-JAN-2011 | 1.56986 | 4.000 | 3.6503 | ||||||||||||||||||||||||||||||
| 04-JAN-2012 | 2.56986 | 4.000 | 3.4437 | ||||||||||||||||||||||||||||||
| 04-JAN-2013 | 3.56986 | 4.000 | |||||||||||||||||||||||||||||||
| 04-JAN-2014 | 4.56986 | 4.000 | |||||||||||||||||||||||||||||||
| 04-JAN-2015 | 5.56986 | 4.000 | 2.8914 | ||||||||||||||||||||||||||||||
| 04-JAN-2016 | 6.56986 | 4.000 | 2.7277 | ||||||||||||||||||||||||||||||
| 04-JAN-2017 | 7.56986 | 4.000 | 2.5733 | ||||||||||||||||||||||||||||||
| 04-JAN-2018 | 8.56986 | 104.000 | 63.1198 | ||||||||||||||||||||||||||||||
| Sum | 88.5893 | ||||||||||||||||||||||||||||||||
| Accrued interest to be substracted | 1.7205 | ||||||||||||||||||||||||||||||||
| Clean price | 86.8688 | ||||||||||||||||||||||||||||||||
The conversion factor, expressed in decimal format is 0.868688.