Risk Management

Summary
Chapter 23 Futures and Forward

Dosen: Farida Ariyani Nurti Wijayanti, SE, MM, CWM

Radityo Heru Prabowo 07/263820/PEK/11716 No. Reg. 19R0712 Kelas Eksekutif 19b

PROGRAM STUDI MAGISTER MANAJEMEN SEKOLAH PASCA SARJANA UNIVERSITAS GADJAH MADA JAKARTA 2008

Seller delivers bond . II. and catastrophe risk. when the seller of the asset agrees to deliver it immediately and the buyer of the asset agrees to pay for the asset immediately. Forward and Futures Contracts Spot contract : an agreement beetwen a buyer and a seller at time 0. FX and credit risk exposures as well as their role in hedging natural catastrophes.I. credit risk. we look at the role futures and forward contracts play in managing an FI’s interest rate. 0 1 2 3 Month Price agreed / paid beetwen buyer and seller + Bonds delivered by seller to buyer Forward contarct : an agreement involving the exchange of an asset for a cash at a fixed price in the future. Overview In this chapter. We then examine how forwards and futures can be used to hedge interest rate. 0 1 2 3 Month Price agreed beetwen buyer and seller Buyer pays forward price. We start with a comparison of forward and futures contract to spot contract. Seller delivered bonds Futures contract : an agreement involving the future exchange of an asset for cash at a price that is determined daily. FX risk. 0 1 2 3 Month Buyer and seller enter futures contract at time 0 future contract Buyer pays the futures price quoted at the end of month 3.

02 1+R = 1 plus the current yield on 20-year bonds = 1. ΔP ΔR = −D × P 1+ R Where : ΔP = Capital loss on bonds P D = Initial value of bond position = $970. . Basis risk : A residual risk that arises because the movement in a spot (cash) asset’s price is not perfectly correlated with the movement in the price of the asset delivered under a futures or forward contract. Selective Hedging : Only partially hedging the gap or individual assets and liabilities.000 = Duration of the bonds = 9 years ΔR = Change in forecast yield = .III. Hedging Interest Rate With Future Contract Microhedging : Using a futures (forward) contract to hedge a specific asset or liabilities.08 Immunized : Describe an FI that is fully hedged or protected against adverse movements in interest rate (or other asset prices) IV. Forward Contract and Hedging Interest Rate Risk Naïve hedge : When a cash asset is hedge on a direct dollar-for-dollar basis with a forward or futures contract. (low risk-low return). Macrohedging : Hedging the entire duration gap of an FI Routine Hedging : Seeking to hedge all interest rate risk exposure. (selectively hedge based on expectations of future interest rates and risk preferences).

ΔE = [Da − kDl ]× A × ΔR 1+ R where : ΔE = Change in an FI’s net worth DA = Duration of its asset portfolio DL = Duration of its liability portfolio k = Ratio of an FI’s liabilities to asset (L/A) A = Size of an FI’s asset portfolio ΔR = Shock to interest rates 1+ R The Risk-Minimizing Futures Option ΔF ΔR = − Dr 1+ R F Δ where : ΔF = Change in dollar value of futures contracts F = Dollar value of the initial futures contracts Dr = Duration of the bond to be delivered against the futures contracts such as a 20-year. 8 percent coupon T-bond ΔR = Expected shock to interest rates 1+R = 1 plus the current level of interest rates .The effect of hedging on risk and expected return Macrohedging with Futures.

S.V. o Specifies a credit spread on a benchmark bond issued by a borrower. o Contract volume is rising. o Catastrophe futures to allow PC insurers to hedge against extreme losses such as hurricanes. Hedging Credit Risk with Futures and Forward Credit Forward Contract and Credit Risk Hedging : An agreement that hedges against an increase in default risk on a loan after the loan terms have been determined and the loan has been issued. o Disclose large contract positions that materially affect bank risk to shareholders and outside investors. o Payoff linked to loss ratio Futures and Forward Policies of Regulators. . Futures Contracts and Catastrophe Risk o CBOT introduced futures and options for catastrophe insurance. o Establish trading limits. o Credit forwards hedge against decline in credit quality of borrower. Example: BBB bond at time of origination may have 2% spread over U. o Common sellers are banks. o Common buyers are insurance companies. Treasury of same maturity. • Three levels of regulation: o Permissible activities o Supervisory oversight of permissible activities o Overall integrity and compliance • • • Functional regulators o SEC and CFTC Beginning in 2000. FDIC and OCC require banks o Establish internal guidelines regarding hedging. derivative positions must be marked-to-market. Federal Reserve.

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