Chapter 6Interest Rate Futures

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OverviewIntroduce Treasury bond futures and Eurodollars futures used to hedge against interest rate movements.Introduce the Duration which measures how sensitive a portfolio is to interest rates and can also be used with interest rate futures contracts to hedge a company’s interest rate movements.

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Conversion Factor The conversion factor for a bond is

approximately equal to the value of the bond on the assumption that the yield curve is flat at 6% with semiannual compounding

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CBOT T-Bonds & T-NotesFactors that affect the futures price:

Delivery can be made any time during the delivery monthAny of a range of eligible bonds can be delivered

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Eurodollar Futures continuedA Eurodollar futures contract is settled in cashWhen it expires (on the third Wednesday of the delivery month) the final settlement price is 100 minus the actual three month Eurodollar deposit rate

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Convexity Adjustment when =0.012 (page 145)

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Maturity of Futures (yrs)

Convexity Adjustment (bps)

2 3.24 12.26 27.08 47.5

10 73.8

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Limitations of Duration-Based Hedging

Assumes that only parallel shift in yield curve take placeAssumes that yield curve changes are smallWhen T-Bond futures is used assumes there will be no change in the cheapest-to-deliver bond

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