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Interest Rate Futures

Chapter 6

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Day Count Conventions

in the U.S. (Page 129)

No. of days between dates

------------------------------------------

No. of days in reference period

Treasury Bonds:

X Interest earned inreference period

Actual/Actual (in period)

Corporate and Municipal Bonds: 30/360

Money Market Instruments: Actual/360

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Treasury Bond Price Quotes

in the U.S

Cash price = Quoted price +Accrued Interest

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Treasury Bond Futures

Pages 133-137

Cash price received by party with shortposition =

Most Recent Settlement Price Conversion factor + Accrued interest

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Example

Settlement price of bond delivered = 90.00

Conversion factor = 1.3800

Accrued interest on bond =3.00 Price received for bond is

1.38009.00)+3.00 = $127.20

per $100 of principal

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Conversion Factor

The conversion factor for a bond isapproximately equal to the value of the

bond on the assumption that the yieldcurve is flat at 6% with semiannualcompounding

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CBOT

T-Bonds & T-Notes

Factors that affect the futures price:

Delivery can be made any time

during the delivery monthAny of a range of eligible bonds

can be delivered

The wild card play

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A Eurodollar is a dollar deposited in a bankoutside the United States

Eurodollar futures are futures on the 3-month

Eurodollar deposit rate (same as 3-monthLIBOR rate)

One contract is on the rate earned on $1 million

A change of one basis point or 0.01 in aEurodollar futures quote corresponds to acontract price change of $25

Eurodollar Futures (Page 137-142)

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Eurodollar Futures continued

A Eurodollar futures contract is settled incash

When it expires (on the third Wednesdayof the delivery month) the final settlementprice is 100 minus the actual three monthdeposit rate

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Example

Date Quote

Nov 1 97.12

Nov 2 97.23

Nov 3 96.98

.

Dec 21 97.42

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Example continued

If on Nov. 1 you know that you will have$1 million to invest on for three months onDec 21, the contract locks in a rate of100 - 97.12 = 2.88%

In the example you earn 100 97.42 =2.58% on $1 million for three months(=$6,450) and make a gain day by day onthe futures contract of 30$25 =$750

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Formula for Contract Value (page 138)

If Qis the quoted price of a Eurodollarfutures contract, the value of one contractis 10,000[100-0.25(100-Q)]

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Forward Rates and Eurodollar

Futures (Page 139-142)

Eurodollar futures contracts last as long as10 years

For Eurodollar futures lasting beyond twoyears we cannot assume that the forwardrate equals the futures rate

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There are Two Reasons

Futures is settled daily where forward issettled once

Futures is settled at the beginning of theunderlying three-month period; forward issettled at the end of the underlying three-month period

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Convexity Adjustment when

=0.012 (Table 6.3, page 141)

Maturity ofFutures

ConvexityAdjustment (bps)

2 3.24 12.2

6 27.0

8 47.5

10 73.8

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Duration Matching

This involves hedging against interestrate risk by matching the durations of

assets and liabilities It provides protection against small

parallel shifts in the zero curve

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Limitations of Duration-Based

Hedging

Assumes that only parallel shift in yieldcurve take place

Assumes that yield curve changes aresmall

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GAP Management (Business Snapshot 6.3)

This is a more sophisticated approachused by banks to hedge interest rate. Itinvolves

Bucketing the zero curve

Hedging exposure to situation where rates

corresponding to one bucket change andall other rates stay the same.