A Note On Interest Rate Futures

EXHIBIT IV

NO ARBITRAGE FUTURES PRICE

At any time, if the cash requirement at point 0 is nil and at point 1, if an investor ends up with cash in hand, then there is some problem in the financial system. Either the repo rate is too low or
the futures price is too high. If the investor can borrow at a lower rate than the implied financing rate from the T-Bill futures market, the investor should borrow for 120 days, buy 210 day T-Bills and sell futures due in 120 days. But, if the borrowing rate is more than the implied financing rate, than the investor should be to borrow for 210 days, buy 120 day T-Bills, and buy futures due in 120 days.

Given the repo rate of 4.85%, the price at which there will be no arbitrage is $94.97.

Total cost of borrowing = $9,71,708 + $15,709.28 = $987417.28

Discount yield on futures = 100 – 94.97 = 5.03%

Price = $10,00,000 (1 – discount yield X 90/360)
= $9,87,425

Source: Strong A. Robert, Derivatives an Introduction.

EXHIBIT V

CHARACTERISTICS OF T-NOTE AND T-BONDS

	5-year US T-Note	10-year US T-Note	US T-Bond
Exchange	CBOT	CBOT	CBOT
Symbol	FV	TY	US
Face Value (or contract size)	$100,000	$100,000	$100,000
Price of quotation	Points and 1/32 of a point	Points and 1/32 of a point	Points and 1/32 of a point
Delivery	7th business day preceding the last business day of the delivery month	7th business day preceding the last business day of the delivery month	7th business day preceding the last business day of the delivery month
Trading months	March, June, September, December	March, June, September, December	March, June, September, December
Minimum change in price allowed	1/32 of a point i.e. $31.25	1/32 of a point i.e. $31.25	1/32 of a point i.e. $31.25

Adapted from Strong A. Robert, Derivatives An Introduction, Hull C. John, Options, Futures and Other Derivatives,Financial Risk Management, IUP, www.cba.uiuc.edu

EXHIBIT VI CHEAPEST TO DELIVER BOND

ADDITIONAL READINGS & REFERENCES