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HEDGING BY FUTURES

HEDGING THE INTEREST RATE RISK

1. Hedging the Cost of Funds

Cash Market Futures Market 17 August

A company expects to borrow

approximately $1 million in two months.

The current rate of interest is 13.5% p.a.,

an is expecte to rise.

(Value of bank bill = $967,784.70)

17 August

Sell one !$1 million" #ecember &ay

ban' bill futures contract at ().5* yiel

of 13.5% p.a.

(Value of futures contract =

$967,784.70)

17 +ctober

#raw bill with a face alue of $1 million

at 15.% p.a.

(Value of bank bill = $964,332.89)

Aitional cost of borrowing on 17

+ctober compare with borrowing on 17

August

- $3,51.(1

17 +ctober

/uy a #ecember &ay ban' bill futures

contract at (5. an thus close out

futures mar'et position.

(Value of futures contract =

$964,332.89)

0rot from closing out of the futures

contract

- $3,51.(1

2. Hedging the Rate of ReturnCash Market Futures Market

17 +ctober

A company expects to hae funs in 3

months time that will enable it to buy $1

million ban' bills* current yiel is 11.75%

p.a.

(Price of bank bill, if bou!t to"a#

= $97, 843.7)

17 +ctober

Buy a 2arch ban' bill futures contract at

((.5* yiel of 11.75% p.a.

(Value of futures contract =

$97,843.7)

17 4anuary

The company buys a &ay $1 millionban' bill at current yiel of 1.5% p.a.

(Price of bank bill = $974,762.98)

all in yiels of 1.5% p.a. oer perio*

aitional cost of bill - $,1.(1

17 4anuary

6ell a 2arch &ay ban' bill futurescontract at (.5.

(Value of futures contract =

$974,762.98)

0rot from closing out of the futures

contract

- $,1.(1 use to oset lower money

mar'et return

%ote8

Norman Cheung 1 Hedging by Futures

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9alue of ban' bill -

365*1 rityDaystoMatu

teInterestRa

FaceValue

+

Norman Cheung 2 Hedging by Futures

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Norman Cheung 4 Hedging by Futures