A Note On Interest Rate Futures
 <<Previous
LONG-TERM HEDGING (HEDGING THE RISK OF A FALL IN INTEREST RATES FOR AN
INVESTMENT)This form of hedging is used to protect
returns on investments made. Assume an investor is expecting a cash inflow
and plans to invest the cash when it is received. He is worried about the
rate at which the investments will be made and would like to hedge the risk
of a fall in interest rates. He can hedge by buying T-Bills or Eurodollar
futures in the futures market today.
Example:
On January 6, 2003, a firm comes to know that it would receive $10 million
on March 15, 2003, from its foreign subsidiary. The firm wishes to invest
the amount in T-Bills. On January 6, 2003, the discount yield on a 3-month
T-Bill is 7.24% while the current implied discount yield on March T-Bill
futures is 7.14%. Since the firm is concerned about a decline in LIBOR rate,
it decides to go long on March T-Bill futures contract to protect itself
from any decline in interest rates. The firm buys 10 March 2003 T-Bill
futures contracts on January 6 at a price of $92.86, locking in the discount
yield of 7.14%. The following two illustrations provide a better explanation
of this transaction:
Case I
The 3-month discount yield on T-Bills falls to 6.5% by March 15 (thus
March futures will be priced at 93.5).
Price of Cash T- bill = $100,00,000 X (1 – 0.065 X 3/12) = $98,37,500
Less: Gain on Futures = (Price Change) X ($25/BP) X 10
= $(93.5 – 92.86) X 100 X 25 X 10
= $16,000
Effective Purchase price = $ 98,21,500
Annualized discount yield
= (100,00,000 – 98,21,500/100,00,000) X 12/3 X 100
= (178500/100,00,000) X 4 X 100
= 7.14% |
|
Case II
The 3-month discount yield on T-Bills rises to 8.5% by March 15 (thus March
futures will be priced at 91.5).
Price of Cash T- bill = $100,00,000 X (1 – 0.085 X 3/12)
= $97,87,500
Add Loss on Futures = (Price Change) X ($25/BP) X 10
= (92.86 – 91.5) X 100 X 25 X 10
= $34,000
Effective Purchase Price = $98,21,500
Annualized discount yield
= [(100,00,000 – 98,21,500)/100,00,000] X 12/3 X 100
= 7.14%
In both cases, the firm has locked in the investment yield at 7.14%. In the
first case, there was a gain on the long futures position of $16000, because of
a decline in the interest rate. In the second case, loss on the futures position
of $34000 was due to an increase in the interest rate.
ARBITRAGE WITH T-BILL FUTURES
SPREADING WITH INTEREST RATE FUTURES
TABLE II TRANSACTIONS INVOLVING BUYING THE TED SPREAD
TREASURY BONDS FUTURES
PRICING OF T-BOND FUTURES CONTRACTS
QUOTED FUTURES PRICE
TABLE III STEPS TO CALCULATE QUOTED FUTURES PRICE
CONCLUSION
EXHIBIT I LIST OF ACTIVELY TRADED SHORT TERM INTEREST RATE FUTURES
EXHIBIT II LIST OF ACTIVELY TRADED LONG TERM INTEREST RATE FUTURES
EXHIBIT III T-BILL FUTURES AND EURODOLLAR FUTURES
EXHIBIT IV NO ARBITRAGE FUTURES PRICE
EXHIBIT V CHARACTERISTICS OF T-NOTE AND T-BONDS
EXHIBIT VI CHEAPEST TO DELIVER BOND
ADDITIONAL READINGS & REFERENCES
2010, ICMR (IBS Center for Management Research).All rights reserved. No part of this publication may be
reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted
in any form or by any means - electronic or mechanical, without permission.
To order copies, call +91- 8417- 236667 or write to ICMR,
Survey No. 156/157, Dontanapalli Village, Shankerpalli Mandal,
Ranga Reddy District,
Hyderabad-501504.
Andhra Pradesh, INDIA.
Mob: +91- 9640901313, Ph: +91- 8417- 236667,
Fax: +91- 8417- 236668
E-mail: info@icmrindia.org
Website: www.icmrindia.org
|
More Classifications...