Chap 6

Chap 6

• 1.
  Interest Rate FuturesChapter 6
• 2.
  Day Count Conventions in the U.S. (Page 129) Actual/360 Money Market Instruments: 30/360 Corporate Bonds: Actual/Actual (in period) Treasury Bonds:
• 3.
  Treasury Bond PriceQuotes in the U.S Cash price = Quoted price + Accrued Interest
• 4.
  Treasury Bond FuturesPages 133-137 Cash price received by party with short position = Most Recent Settlement Price × Conversion factor + Accrued interest
• 5.
  Example Settlement priceof bond delivered = 90.00 Conversion factor = 1.3800 Accrued interest on bond =3.00 Price received for bond is 1.3800 ×9.00)+3.00 = $127.20 per $100 of principal
• 6.
  Conversion Factor Theconversion factor for a bond is approximately equal to the value of the bond on the assumption that the yield curve is flat at 6% with semiannual compounding
• 7.
  CBOT T-Bonds &T-Notes Factors that affect the futures price: Delivery can be made any time during the delivery month Any of a range of eligible bonds can be delivered The wild card play
• 8.
  A Eurodollar isa dollar deposited in a bank outside the United States Eurodollar futures are futures on the 3-month Eurodollar deposit rate (same as 3-month LIBOR rate) One contract is on the rate earned on $1 million A change of one basis point or 0.01 in a Eurodollar futures quote corresponds to a contract price change of $25 Eurodollar Futures (Page 137-142)
• 9.
  Eurodollar Futures continuedA Eurodollar futures contract is settled in cash When it expires (on the third Wednesday of the delivery month) the final settlement price is 100 minus the actual three month deposit rate
• 10.
  Example Suppose youbuy (take a long position in) a contract on November 1 The contract expires on December 21 The prices are as shown How much do you gain or lose a) on the first day, b) on the second day, c) over the whole time until expiration?
• 11.
  Example 97.42 Dec21 …… …… . 96.98 Nov 3 97.23 Nov 2 97.12 Nov 1 Quote Date
• 12.
  Example continuedIf on Nov. 1 you know that you will have $1 million to invest on for three months on Dec 21, the contract locks in a rate of 100 - 97.12 = 2.88% In the example you earn 100 – 97.42 = 2.58% on $1 million for three months (=$6,450) and make a gain day by day on the futures contract of 30 ×$25 =$750
• 13.
  Formula for ContractValue (page 138) If Q is the quoted price of a Eurodollar futures contract, the value of one contract is 10,000[100-0.25(100- Q )]
• 14.
  Forward Rates andEurodollar Futures (Page 139-142) Eurodollar futures contracts last as long as 10 years For Eurodollar futures lasting beyond two years we cannot assume that the forward rate equals the futures rate
• 15.
  There are TwoReasons Futures is settled daily where forward is settled once Futures is settled at the beginning of the underlying three-month period; forward is settled at the end of the underlying three- month period
• 16.
  Forward Rates andEurodollar Futures continued
• 17.
  Convexity Adjustment when  =0.012 (Table 6.3, page 141) 73.8 10 47.5 8 27.0 6 12.2 4 3.2 2 Convexity Adjustment (bps) Maturity of Futures
• 18.
  Extending the LIBORZero Curve LIBOR deposit rates define the LIBOR zero curve out to one year Eurodollar futures can be used to determine forward rates and the forward rates can then be used to bootstrap the zero curve
• 19.
  Example so thatIf the 400 day LIBOR rate has been calculated as 4.80% and the forward rate for the period between 400 and 491 days is 5.30 the 491 days rate is 4.893%
• 20.
  Duration Matching Thisinvolves hedging against interest rate risk by matching the durations of assets and liabilities It provides protection against small parallel shifts in the zero curve
• 21.
  Use of EurodollarFutures One contract locks in an interest rate on $1 million for a future 3-month period How many contracts are necessary to lock in an interest rate for a future six month period?
• 22.
  Duration-Based Hedge RatioDuration of portfolio at hedge maturity D P Value of portfolio being hedged P Duration of asset underlying futures at maturity D F Contract price for interest rate futures F C
• 23.
  Example Itis August. A fund manager has $10 million invested in a portfolio of government bonds with a duration of 6.80 years and wants to hedge against interest rate moves between August and December The manager decides to use December T-bond futures. The futures price is 93-02 or 93.0625 and the duration of the cheapest to deliver bond is 9.2 years The number of contracts that should be shorted is
• 24.
  Limitations of Duration-BasedHedging Assumes that only parallel shift in yield curve take place Assumes that yield curve changes are small
• 25.
  GAP Management (Business Snapshot 6.3) This is a more sophisticated approach used by banks to hedge interest rate. It involves Bucketing the zero curve Hedging exposure to situation where rates corresponding to one bucket change and all other rates stay the same.