Upload
kaushikamit876385
View
222
Download
0
Embed Size (px)
Citation preview
8/8/2019 3. Intrest Rate Futures
1/28
Forward Contracts and Forward
Rate Agreements (FRA)
Forward contracts for interest rate products areprivate, customized contracts between two financialinstitutions or between a financial institution and one
of its clients.
A good example of an interest rate forward productis a forward rate agreement, FRA.
8/8/2019 3. Intrest Rate Futures
2/28
Forward Contracts and Forward
Rate Agreements (FRA)
FRAs originated in 1981 amongst large London
Eurodollar banks that used these forward agreements
to hedge their interest rate exposure.
Today, FRAs are offered by banks and financial
institutions in major financial centers and are often
written for the banks corporate customers.
They are customized contracts designed to meet the
needs of the corporation or financial institution.
8/8/2019 3. Intrest Rate Futures
3/28
Forward Contracts and Forward
Rate Agreements (FRA)
Most FRAs do follow the guidelines established by
the British Bankers Association.
Settlement dates do tend to be less than one year (e.g.,
3, 6, or 9 months), although settlement dates going
out as far as four years are available.
The NP on a FRA can be as high as a billion and can
be drawn in dollars, British pounds and other
currencies.
8/8/2019 3. Intrest Rate Futures
4/28
Forward Contracts and Forward
Rate Agreements (FRA)
FRAs are used by corporations and financial
institutions to manage interest rate risk in the same
way as financial futures are used.
Different from financial futures, FRAs are contracts
between two parties and therefore are subject to the
credit risk of either party defaulting.
The customized FRAs are also less liquid than
standardized futures contracts.
8/8/2019 3. Intrest Rate Futures
5/28
8/8/2019 3. Intrest Rate Futures
6/28
Forward Contracts and Forward
Rate Agreements (FRA)
In five months the payoff would be
If the LIBOR at the end of five months exceeds the specified
rate of 6%, the buyer of the FRA (or long position holder)
receives the payoff from the seller.
If the LIBOR is less than 6%, the seller (or short position
holder) receives the payoff from the buyer.
? A)365/91(LIBOR1
)365/91(06.LIBOR
)M10($Payoff
!
8/8/2019 3. Intrest Rate Futures
7/28
Forward Contracts and Forward
Rate Agreements (FRA)
If the LIBOR were at 6.5%, the buyer would be
entitled to a payoff of $12,267 from the seller;
If the LIBOR were at 5.5%, the buyer would be
required to pay the seller $12,297.
8/8/2019 3. Intrest Rate Futures
8/28
Interest rate futures
In case of interest rate futures the underlying assets will be differentinterest rate bearing instruments.
An interest rate futures contract is an agreement to buy or sell astandard quantity of specific interest bearing instruments at apredetermined future date and at the price agreed upon between theparties
The money lenders stand to lose if the interest rates go down infuture.
The money borrowers stand to lose if the interest rates go up infuture.
Of these contracts, the four most popular are
Short term Interest rate future contracts are
Eurodollar deposits T-bills
Long term Interest rate future contracts are T-bonds
T-notes
8/8/2019 3. Intrest Rate Futures
9/28
Contract Exchange Contract Size
Treasury Bond
5-Year Treasury Note
Treasury Note
3-Month Treasury Bill
3-Month Eurodollar
1-Month LIBOR
Municipal Bond Index
3-Month Euroyen
10-year Japanese Government
Bond Index
Long Gilt
3-Month Sterling Interest Rate
CBOT
CBOT
CBOT
CME
CME
CME
CBOT
SIMEX
TSE
LIFFE
LIFFE
T-bond with $100,000 face value (or multiple of that)
T-note with $100,000 face value (or multiple of that)
T-note with $100,000 face value (or multiple of that)
$1,000,000
$1,000,000
$3,000,000
$1,000 times the closing value of theBond BuyerTM
Municipal Bond Index (a price of 95 means a contract size
of $95,000)
100,000,000 yen
100,000,000 yen face value
50,000 British pound
500,000 British pound
Futures Exchanges
8/8/2019 3. Intrest Rate Futures
10/28
Main factors behind the growth of
interest rate futures
Enormous growth of the market for fixedincrease securities
Increased fluctuation in interest rates world
wide.
8/8/2019 3. Intrest Rate Futures
11/28
Short term Interest rate future
contracts Eurodollar deposits
T-bills
8/8/2019 3. Intrest Rate Futures
12/28
T-Bill Futures
Expiration months on T-bill futures are March, June,September, and December, and extend out about twoyears.
The last trading day occurs during the third week ofthe expiration month.
Under the terms of the contract, delivery may occuron one of three successive business days with thedelivered T-bill having a maturity of 89, 90, and 91days.
8/8/2019 3. Intrest Rate Futures
13/28
T-Bill Futures
T-bill futures contracts call for the delivery (short
position) or purchase (long position) of a T-bill with
a maturity of 91 days and a face value (F) of $1
million. Futures prices on T-bill contracts are quoted
in terms of an index.
This index, I, is equal to 100 minus the annual
percentage discount rate, RD, for a 90-day T-bill:
( )R100I D!
8/8/2019 3. Intrest Rate Futures
14/28
In futures contract, one tick means one basis point or
0.01%.
The minimum price change allowed is one basispoint.
For one contract it is $10,00000 * 0.01% * 3/12= $25
T- Bill Futures
8/8/2019 3. Intrest Rate Futures
15/28
T-Bill Futures
Given a quoted index value or discount yield,
the actual contract price (purchase Price) on
the T-bill futures contract is:
{Index- (Discount rate * days tomaturity/360)}/100
Or {Face Value/ (1+ Yield Rate) * days to
maturity/365}
000,000,1$100
)360/90%(R100f D0
!
8/8/2019 3. Intrest Rate Futures
16/28
T-Bill Futures
Example: A T-bill futures contract quoted at asettlement index value of 95.62 (RD = 4.38%) would
have a futures contract price (f0) of $989,050 and an
implied YTMof 4.515%:
YTM ={(Face value- Purchase Price) issue Price} * 360/ No. of
days to maturity Or (face Value/Purchase Price) 365/No. of days to Maturity -1
050,989$000,000,1$100
)360/90(38.4100f0 !
!
04515.1050,989$
000,000,1$YTM
1f
FYTM
91/365
f
91/365
0
f
!
-
!
-
!
8/8/2019 3. Intrest Rate Futures
17/28
Another point of interest is the implied rapo
rate which is the rate of return on an annual
basis that yields if one buys a cash T-Billand sells a T-Bill futures at the same time.
IRR= (FPtT CPtT/CPtT) X 360/T-t
T-Bill Futures
8/8/2019 3. Intrest Rate Futures
18/28
Example
18
E.g. a T-bill futures contract is priced with a discount of 8.25.
The futures price is observed as 100 8.25 = 91.75 (think of this91.75 as a price index and it is called the IMM Index)
The actual futures price is calculated as:
f = 100 [(100 IMM Index) (90 / 360)]
f = 100 [(8.25) (90 / 360)] = 97.9375
The standard contract size is $1,000,000
The futures price is $979,375
By assuming a 90-day bill in the formula
Each one basis point move in the IMM index corresponds to a $25
change in the futures price: 0.0001 x $1 million x 90/360 = $25
If the IMM index goes up to 91.76 (from 91.75), the futures pricebecomes $979,375 + 25 = $979,400
8/8/2019 3. Intrest Rate Futures
19/28
8/8/2019 3. Intrest Rate Futures
20/28
Eurodollar Futures Contract
The CME's futures contract on the Eurodollardeposit has a face value of $1 million and amaturity of 90 days.
The expiration months on Eurodollar futurescontracts are March, June, September, andDecember and extend up to ten years.
8/8/2019 3. Intrest Rate Futures
21/28
Eurodollar Futures Contract
Like T-bill futures contracts, Eurodollar
futures are quoted in terms of an index equal
to 100 minus the annual discount rate, with
the actual contract price found by using thefollowing equation:
000,000,1$100
)360/90(100
f0
!
8/8/2019 3. Intrest Rate Futures
22/28
Eurodollar Futures Contract
Example, given a settlement index value of
95.09 on a Eurodollar contract, the actual
futures price would be $987,725:
725,987$000,000,1$100
)360/90(91.4100f0 !
!
8/8/2019 3. Intrest Rate Futures
23/28
Eurodollar Futures Contract
The major difference between the Eurodollar andT-bill contracts is that Eurodollar contracts have cash
settlements at delivery, while T-bill contracts call for
the actual delivery of the instrument.
When a Eurodollar futures contract expires, the cash
settlement is determined by the futures price and the
settlement price.
8/8/2019 3. Intrest Rate Futures
24/28
Eurodollar Futures Contract
The settlement price or expiration futures indexprice is 100 minus the average three- month LIBOR
offered by a sample of designated Euro-banks on the
expiration date:
Expiration Futures Price = 100 - LIBOR
8/8/2019 3. Intrest Rate Futures
25/28
TED Spread
TED spread is the difference between the price of a3 month T bill futures contract and a 3 month
Eurodollar time deposit futures contract, both
expiring on the same day.
8/8/2019 3. Intrest Rate Futures
26/28
Hedging interest rate with the
interest rate futures
1. Hedging a rise in interest rate (for
borrowing decision) or short term hedging
2. Hedging a fall in interest rate ( for
investing decisions ) or a long term hedging
8/8/2019 3. Intrest Rate Futures
27/28
SyntheticH
edgingSpot Security+ future contract= Synthetic
Security
Eg- It is possible to create a synthetic T-bill
for a period of 6- months by
simultaneously investing in a 10 month cash
T-Bill and selling a 4 month T-Bill future.
8/8/2019 3. Intrest Rate Futures
28/28
Strip and stackH
edging Buying various futures contracts with
different delivery times which are matching
the investor risk exposure date. Basis risk islow , liquidity is tight.
Buying various futures contracts which are
concentrated in the nearby delivery month.Basis risk is more but liquidity is high