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HEDGING WITH KLIBOR FUTURES
In KLIBOR futures market..Potential borrowers are concerned about the rising
interest rate, higher interest expense can create an operating loss
Potential lenders are concerned about falling interest rate, lower interest revenue can contribute a lower operating profit
Interest rate risk in the financial market can be reduce, if not eliminate through..
1. Buying Hedge2. Selling Hedge
ESTABLISHMENT OF A LONG (BUYING) HEDGE Anticipation of falling interest rates will
undertake a buying hedge. Requires to buy KLIBOR futures because
they expect the price to increase in the future or interest rate is expected to fall.
Buy today at lower price and hopes to sell futures at a higher price.
HEDGING AGAINST FALLING INTEREST RATE As a treasurer of a large insurance
company, you expect an excess fund of RM200 million for 3 month in December to de deposited in the KLIBOR market. Today is October, in which 3 month KLIBOR is quoting at 4.5% per annum while December futures is trading at 95.1 in the BMDM. In anticipation for falling interest rates, establish your hedging strategy by showing your effective interest rate(EIR) if the cash rate trades at 3.8% and December futures at 96.5.
Future PositionFuture Profit= [SP-BP] x 100 x Contract size x Minimum contract price* multiplied by 100 to derive at basis point
Cash PositionInterest Revenue= Principal x Rate x Time
Net Effect = Future Profit + Cash Position EIR = Total Interest Revenue
Principal x Time
The treasurer receives an effective interest rate (EIR) of 5.2% with hedging, instead of 3.8% without hedging.
Futures profit can be use to compensate expected losses in revenue as a result of falling interest rate to 3.8%.
Lets say, interest rate has unexpectedly risen to 5% at maturity date…
Future Loss = (RM50,000) Interest Revenue = RM2,500,000 Net Effect = RM2,450,000 EIR = 4.9%
If he received RM200 mil in Oct, it can be deposited at a rate of 4.5%.
However, by hedging, he has in fact pre-determined his lending rate at 4.9% that help to avoid and adverse declines in interest rates between Oct and Dec.
Hedging strategy assure him equivalent rate of at least 4.9% or better when interest rate falls.
HEDGING AGAINST RISING INTEREST RATES Mr. Paul, the Treasurer of Worldwide
Finance Company has just determined that there will be a RM180 million shortage of fund for the company three months from now. That amount will have to be raised in the interbank market. Worldwide’s cost of fund is normally the KLIBOR rate. Mr. Paul is however worried about the interest exposure. Assuming the following quotations are available now:
1-month KLIBOR 6.8%
3-month KLIBOR 7.0%
Spot-month KLIBOR futures 93.00
3-month KLIBOR futures 92.00
Assuming the spot 3-month KLIBOR is higher by 1.3%, 3 months later and that the spot and futures market converge, analyze the hedge and show that by using your strategy the intended interest rate has been locked-in (effective interest rate).
Assuming the spot 3-month KLIBOR is higher by 1.3%, 3 months later and that the spot and futures market converge, analyze the hedge and show that by using your strategy the intended interest rate has been locked-in (effective interest rate).
3. Net Effect= Future profit + Interest revenue
4. EIR= Total interest revenue
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