Chapter 6 Interest Rate Futures SOLUTIONS TO QUESTIONS AND PROBLEMS: Problem 6.1. There are 33 calendar days between July 7, 2004 and August 9, 2004. There are 184 calendar days between July 7, 2004 and January 7, 2005. The interest earned por $100 of principal is therefore 3.5 x 33/184 = $0.6277. For a corporate bond we assume 32 days between July 7 and August 9, 2004 and 180 days hetween July 7, 2004 and Janwary 7, 2005. The interest earned is 3.5 x 32/180 = $0.6222. Problem 6.2. ‘There are 89 days between October 12, 2004, anc! January 9, 2005. There are 182 days between October 12, 2004, and April 12, 2005. The cash price of the bond is obtained by adding the acomed interest to the quoted price, The quoted price is 1024) or 102.21875. The cash price is therefore Problem 6.3. ‘The conversion factor for a bond is equal to the quoted price the bond would have per dollar of principal on the first day of the delivery month on the assumption that the interest rate for all maturities equals 6% per annum (with semiannual compounding). The bond maturity and the times to the coupon payment dates are rounded down to the nearest three months for the purposes of the calculation. ‘The conversion factor defines how much an investor with a short bond futures contract receives when bonds are delivered. Ifthe conversion fuctor is 1.2345 the jount investor receives is calculated by multiplying 1.2345 by the most recent futures price and adding acerued interest Problem 6.4. The Furodollar futures price has increased by 6 basis points, The investor makes u gain p contract of 25 x 6 = $150 or $300 in total,Problem 6.3 Suppose that « Kurodoilar futures quote is 95.00, This gives a futures rate of 5% Tor the three-month period covered by the contract, The convexity adjustments the amount by which futures rate hay to be reduced 10 give an estimate of the forward rate for the period ‘The coy venity adjustment is necessary because a) the futures contract is settled daily and b) the futures Contract expires at the beginning of the three months. Both of these Kead to the futures rate ‘greater than the forward rate being Problem 6.6. From equattion (6.4) the rate is 3350 TARO _ 3.0409 oF 3.0409% Problem 6.7. ‘The value of a contract is 108 $108. 468.75. The number of contracts that should be shorted is 82_ “76 60 contracts should be shorted, The position should 0.7 Rounding to the nearest whole numbe be closed out at the end of Poly Problem 6.8. The eash price of the Treasury bill is 100- The annualized cont 365 2.5 melts Problem 6.9. ver of days between January 27. 2003 and May 5, 2003 is 98. The number of days 2003 and July 27, 2003 is 181. The accrued interest is therefore The nun between January 98. 6x = 3.2486 iI36 Chapter 6, Interest Rate Futures ‘The quoted price is 110.5312. The eash price is therefore 110.5342~3.2486 = [13.7798 6.10. ‘The cheapest-to-deliver bond is the one for which Quoted Price ~ Futures Price x Conversion Factor is Teast. Calculating this factor for euch of the 4 bonds w Bond 1: 125.1562 — 101.375 « 1.2031 = 2.178 Bond 2: 142.46875 — 101.375 x 1.3792 = 2.652 Bond 3: 115,96875 -- 101.375 1.1149 = 2.946 Bond 4: 144.06250— 101.375 x 1.4026 = 1.874 Bond 4 is therefore the cheapest to deliver Problem 6.11. ‘There are | August 4. The days between February 4 and July 30 and 182 days between February 4 and ash prive of the bond is, therefore: 7 NO-+— = x 6.5 = 116.32 182 ‘The rate of interest with continuous compounding is 2In 1.06 = 0.1165 oF 11.65% A coupon of 6.5 will be received in 5 % per annum, ss (= 0.01366 years) time, The present value of the coupon is 7 ea 20.1165 — 6.490 The futures contract lasts for 62 days (= 0.1694 years). The cash futures price ifthe contract ‘were written on the 13% bond would be (116.326 .490}e21*0.65 _ 119.02 At delivery there are 57 days of acerued interest. The quoted futures price if the contract were written on the 13% bond would therefore be 112.02 -6.5 x 25 = 110.01 x the conversion luctor into account the quoted futures price should be: 110.01 334 1S