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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 .

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