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# Short Term Interest Rate Futures

Description of contracts and hedging strategies

Short Term Interest Rate Futures  Defined as:  A futures contract on the interest rate applicable to an interbank transaction that begins life on the delivery day of the future. .  Thus the interest rate must be a forward rate of interest.

Short Term Interest Rate Futures  Form of Price Quotation.  Futures price quotation is ± 100 minus the annualised forward rate ± Thus if the forward rate is 10%pa ± the futures quote will be ± 100-10 = 90 ± So as rates go up. the futures price goes down ± and as rates go down. the futures price goes up .

June September and December.Short Term Interest Rate Futures  Typical Contract Specifications:  Three Month Eurodollar Contract on IMM Chicago ± Underlying Deposit: \$1.25) . plus first three months.000  Delivery: March.  Tick size: one half of one basis point (one quarter for near month contract)  Tick Value \$12.50 (6.000.

 The 90 day forward rate 135 day out in a 360 day market is FR135 / 225 « ¨ 225 ¸ » ¬1  © 0. And the 135 day LIBID .10% pa.1* 135 ¼ 90 ¬ ¼ 360 ­ ½ .1025 * 360 ¹ ¼ 360 º  1¼ * !¬ ª ! 10.25% pa.Short Term Interest Rate Futures  Calculation of forward rates  Assume: 225 day LIBOR =10.24 ¬ 1  (0.

Short Term Interest Rate Futures  Hedging with futures. .  Remember as rates rise.  So to hedge against rate falling ± buy futures  To hedge against rates rising ± sell futures. STIR futures prices fall.

.Short Term Interest Rate Futures  To hedge the interest rate on a future cash flow we need to know: ± The scale of the cash position to be hedged and the nominal value of the deposit underlying the future ± The duration or money equivalence of the cash position and the future.

£500.Short Term Interest Rate Futures  The nominal value of the deposit underlying the future is given by the futures contract specifications eg \$1.000 for the contract in London. .000.000 for the three month contract in Chicago.

We will call this the Nominal Value of a Basis Point (NV01).Short Term Interest Rate Futures  The moneyness of the futures contract is the Price Value of a Basis Point (PV01). In the case of the LIBOR contract on CME it is twice the tick size (four times for the near month)  The moneyness of the cash-flow to be hedged reflects how the cash-flow will change as the interest rate changes by one basis point. . This is not always equal to the Tick Value.

Short Term Interest Rate Futures  Number of futures to trade to establish hedge: FVCP NV 01H n! * NVFT PV 01F  Where: ± FVCP = Face value of cash position ± NVFT = Notional amount underlying the future .

Short Term Interest Rate Futures  Hedging Case:  Assume a \$25.000.  You wish to hedge the roll-over in three months time. using three month Eurodollar future on the IMM .000 paying three month LIBOR.

25*1.000.Short Term Interest Rate Futures  Calculating the number (n) of the futures to trade. 000.0001) 25.  NV01 of \$1. 000 25 n! * ! 25 1.000 three month deposit is \$25. 000. 000 25 .  PV01 of future is \$25 (0.000*0.000.

65 when the hedge is established  Assume three month LIBOR at the reset date is 8.  Assume futures price is 90. that implies a futures price of 91.  Thus the futures position will pay 60*\$25*25=\$37. .500 in variation margin..75% pa.Short Term Interest Rate Futures  Calculating the effectiveness of the futures hedge.25.

Short Term Interest Rate Futures  Calculating the effectiveness of the futures hedge cont.  The roll-over is 0.006*\$25.500  NB Eurodollar markets assume a 360 day year! .000 = \$37.6% pa lower than the forward rate implied when the hedge was established.000.000.000 90 day deposit is 0.  The fall in interest revenue on the \$25.25*0.

 PV01 of future is \$25 6.000.000.000.Short Term Interest Rate Futures  Calculating the number (n) of the futures to trade to hedge a six month deposit.  NV01 of \$1.000 six month deposit is \$50.000 50 n! * ! 12 1.000 25 .