FMG5 – HEDGING

Anticipation of Falling Interest rates

QUESTION 1

1. No. of contracts = Amount of Principal

Principal Value

No. of contracts = 50,000,000

100,000

= 500 contracts

2. Outlined Strategies
Market
Cash market Futures market
Month
Bank intends to buy RM50 Open position:
million 5-year MGS in March. Buy500 contracts of March
Current interest rate: 8.50% FMG5 @ 112.95
Today
(Expect interest rate to fall,
price to rise, therefore Buy)

Bank buys RM50 million Close out position:

5-year MGS. Bond yields have Sell500 contracts of March
Later
fallen from 8.5% to 8% making FMG5 @ 113.13
the bonds more expensive.

3. Futures Profit = (Selling – Buying) x no. of contracts x 100 x RM10

= (113.13 – 112.95) x 500 x 100 x RM10
= RM90,000

4. Cash Position = (Ending price – Beginning price) x Amount of principal

Beginning price

=(113.13 – 112.95) x RM50,000,000

112.95

= RM79,681.27

5. Net Effect = Futures profit – cash position ± Amount of principal

=RM90,000 – RM79,681.27– RM50,000,000

= (RM49,989,681.27)

6. Effective interest rate (EIR) = Net effect x Ending price

 Amount of principal

= RM49,989,681.27 x 113.13
RM50,000,000

= 113.11

7. Comment on the outcome of strategy:

With hedging, the bank is able to buy at an effectively lower price at 113.11 instead of 113.13
without hedging and hence, achieved its price objective.

Anticipation of Rising Interest rates

QUESTION 2

1. No. of contracts = Amount of Principal

Principal Value

= 10,000,000
100,000

= 100 contracts

2. Outlined Strategies
Market
Cash market Futures market
Month
Bank intends to sell RM10 Open position:
million 5-year MGS in Sell 100 contracts of
December. December FMG5 @ 113.13
Today Current interest rate: 5.50%
(Expect interest rate to rise,
price to fall, therefore Sell)

BankSellsRM10 million 5-year Close out position:

MGS. Bond yields have risen Buy100 contracts of
Later
from 5.5% to 6% making the December FMG5 @ 112.95
bonds cheaper.

3. Futures Profit = (Selling – Buying) x no. of contracts x 100 x RM10

= (113.13 – 112.95) x 100 x 100 x RM10
= RM18,000

4. Cash Position = (Ending price – Beginning price) x Amount of principal

Beginning price

= (112.95 – 113.13) x RM10,000,000

 113.13

= RM15,910.90

5. Net Effect = Futures profit – cash position ± Amount of principal

=RM18,000 – RM15,910.90 + RM10,000,000

= RM10,002,089.10

6. Effective interest rate (EIR) = Net effect x Ending price

Amount of principal

= RM10,002,089.10 x 112.95
RM10,000,000

= 112.97

7. Comment on the outcome of strategy:

With hedging, the bank is able to sell at an effectively higher price at 112.97 instead of 112.95
without hedging and hence, achieved its price objective.

FMG5 – SPECULATION

Anticipation Rising Prices

QUESTION 3

1. i) Initial Margin = RM x no. of contracts

= RM10,000 x 10 = RM100,000

ii) Maintenance Margin = RM x no. of contracts

= RM8,500 x 10 = RM85,000

2. Marked-to-market position (Table)

Day Closing Price Floating Variable Margin

(RM) Profit/Loss
0 113.05 - 100,000
1 113.02 (300) 99,700
2 113.07 500 100,200
3 113.12 500 100,700
4 113.11 (100) 100,600
5 113.04 (700) 99,900

(w1) Floating Profit/Loss (Daily)

 Day 1 = (Selling – Buying) x no. of contracts x 100 x RM10
= (113.02 – 113.05) x 10 x 100 x RM10 = (RM300)
Day 2 = (113.07 – 113.02) x 10 x 100 x RM10 = RM500
Day 3 = (113.12 – 113.07) x 10 x 100 x RM10 = RM500
Day 4 = (113.11 – 113.12) x 10 x 100 x RM10 = (RM100)
Day 5 = (113.04 – 113.11) x 10 x 100 x RM10 = (RM700)

3. Realized Profit/Loss
= (Selling – Buying) x no. of contracts x 100 x RM25
= (113.04 – 113.05) x 10 x 100 x RM10 = (RM100)
OR
= Ending Margin – initial margin
= 99,900 – 100,000 = (RM100)

4. Leverage Effects:
i) Percentage change in PRICE
= (113.04 – 113.05) x 100 = - 0.0088%
113.05

ii) Percentage change in RETURN

= (99,900 – 100,000) x 100 = - 0.1%
100,000

5. Comment on the results:

A small decrease in price (0.0088%) can lead to a bigger decrease in return by 0.1%.

Anticipation Falling Prices

QUESTION 4

1. i) Initial Margin = RM x no. of contracts

= RM8,500 x 5= RM42,500

ii) Maintenance Margin = RM x no. of contracts

= RM6,500 x 5= RM32,500

2. Marked-to-market position (Table)

Day Closing Price Floating Variable Margin

(RM) Profit/Loss
0 113.05 - 42,500
1 113.02 150 42,650
2 113.07 (250) 42,400
3 113.12 (250) 42,150
4 113.11 50 42,200
5 112.95 800 43,000
(w1) Floating Profit/Loss (Daily)
 Day 1 = (Selling – Buying) x no. of contracts x 100 x RM10
= (113.05 – 113.02) x 5 x 100 x RM10 = RM150
Day 2 = (113.02 – 113.07) x 5 x 100 x RM10 = (RM250)
Day 3 = (113.07 – 113.12) x 5 x 100 x RM10 = (RM250)
Day 4 = (113.12 – 113.11) x 5 x 100 x RM10 = RM50
Day 5 = (113.11 – 112.95) x 5 x 100 x RM10 = RM800

3. Realized Profit/Loss
= (Selling – Buying) x no. of contracts x 100 x RM25
= (113.05 – 112.95) x 5 x 100 x RM10 = RM500
OR
= Ending Margin – initial margin
= 43,000 – 42,500 = RM500

4. Leverage Effects:
i) Percentage change in PRICE
= (112.95 – 113.05) x 100 = - 0.088%
113.05

ii) Percentage change in RETURN

= (43,000 – 42,500) x 100 = 1.18%
42,500

5. Comment on the results:

A small decrease in price (0.088%) can lead to a bigger increase in return by 1.18%.

FMG5 –SPREADING (Inter-month Spread)

Anticipation of Falling Prices

QUESTION 5

1. Explain the strategies:

This is an inter-month spread. Since the market is expected to bearish, therefore, the
strategy will be to sell contract that is quoted at a higher price (March FMG5) and
simultaneously buy contract that is quoted at a lower price (December FMG5) today.

2. Outline strategies in table.

Contract
December FMG5 March FMG5 Spread
Period
Buy 6 contracts@ Sell 6 contracts @
Today 115.42 115.79 37bp
 Sell 6 contracts @ Buy 6 contracts @
Later 58bp
113.02 112.44

Spread -240bp 335bp 95

3. Spread Profit/ Net profit:

December FMG5 = (113.02 – 115.42) x 6 x 100 x RM10 = (RM14,400)

March FMG5 = (115.79 – 112.44) x 6 x 100 x RM10 = RM20,100

Commission charges = RM100 x 6 x 2 = (RM1,200)

Spread profit =RM4,500 OR

iii) Spread Profit = 95 bp x 6 x RM10 – (RM100 x 6 x 2) = RM4,500

Anticipation of Rising Prices

QUESTION 6

1. Explain the strategies:

This is an inter-month spread. Since the market is expected to bullish and the spread is
narrowing, therefore, the strategy will be to buy contract/distant month that is quoted at a
lower price (December FMG5) and simultaneously sell contract/nearby month that is quoted
at a higher price (September FMG5) today.

2. Outline strategies in table.

Contract December FMG5 September FMG5

Spread
Period (Distant) (Nearby)
Buy 10 contracts@ Sell 10 contracts @
Today 102.70 102.95 25bp

Sell 10 contracts @ Buy 10 contracts @

Later 460bp
110.25 105.65

Spread 755bp -270bp 485

3. Spread Profit/ Net profit:

 December FMG5 = (110.25 – 102.70) x 10 x 100 x RM10 = RM75,500

September FMG5 = (102.95 – 105.65) x 10 x 100 x RM10 = (RM27,000)

Spread profit = RM48,500 OR

iii) Spread Profit = 485bp x 10 x RM10 = RM48,500