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Hedging With STIR Futures

Short Term Interest Rate Futures Defined as: a futures contract on the interest rate applicable to an interbank transaction that begins life on the delivery day of the future. The moneyness of the cash-flow to be hedged is the price value of a Basis Point (PV01) this is not always equal to the tick size (four times for the near month contract) in the case of the LIBOR contract on CME it is twice the tick size.

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Bach Nguyen Hoai Anh
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281 views15 pages

Hedging With STIR Futures

Short Term Interest Rate Futures Defined as: a futures contract on the interest rate applicable to an interbank transaction that begins life on the delivery day of the future. The moneyness of the cash-flow to be hedged is the price value of a Basis Point (PV01) this is not always equal to the tick size (four times for the near month contract) in the case of the LIBOR contract on CME it is twice the tick size.

Uploaded by

Bach Nguyen Hoai Anh
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPT, PDF, TXT or read online on Scribd
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Short Term Interest Rate Futures

Description of contracts and hedging strategies

Short Term Interest Rate Futures


Defined as: A futures contract on the interest rate applicable to an interbank transaction that begins life on the delivery day of the future. Thus the interest rate must be a forward rate of interest.

Short Term Interest Rate Futures


Form of Price Quotation. Futures price quotation is
100 minus the annualised forward rate Thus if the forward rate is 10%pa the futures quote will be 100-10 = 90 So as rates go up, the futures price goes down and as rates go down, the futures price goes up

Short Term Interest Rate Futures


Typical Contract Specifications: Three Month Eurodollar Contract on IMM Chicago
Underlying Deposit: $1,000,000

Delivery: March, June September and December, plus first three months. Tick size: one half of one basis point (one quarter for near month contract) Tick Value $12.50 (6.25)

Short Term Interest Rate Futures


Calculation of forward rates Assume: 225 day LIBOR =10.25% pa. And the 135 day LIBID - 10% pa. The 90 day forward rate 135 day out in a 360 day market is
FR135 / 225 225 1  0.1025 * 360 360  1 * ! ! 10.24 1  (0.1* 135 90 360

Short Term Interest Rate Futures


Hedging with futures. Remember as rates rise, STIR futures prices fall. So to hedge against rate falling
buy futures

To hedge against rates rising


sell futures.

Short Term Interest Rate Futures


To hedge the interest rate on a future cash flow we need to know:
The scale of the cash position to be hedged and the nominal value of the deposit underlying the future The duration or money equivalence of the cash position and the future.

Short Term Interest Rate Futures


The nominal value of the deposit underlying the future is given by the futures contract specifications eg $1,000,000 for the three month contract in Chicago, 500,000 for the contract in London.

Short Term Interest Rate Futures


The moneyness of the futures contract is the Price Value of a Basis Point (PV01). This is not always equal to the Tick Value. In the case of the LIBOR contract on CME it is twice the tick size (four times for the near month) The moneyness of the cash-flow to be hedged reflects how the cash-flow will change as the interest rate changes by one basis point. We will call this the Nominal Value of a Basis Point (NV01).

Short Term Interest Rate Futures


Number of futures to trade to establish hedge: FVCP NV 01H n! * NVFT PV 01F Where:
FVCP = Face value of cash position NVFT = Notional amount underlying the future

Short Term Interest Rate Futures


Hedging Case: Assume a $25,000,000 paying three month LIBOR. You wish to hedge the roll-over in three months time, using three month Eurodollar future on the IMM

Short Term Interest Rate Futures


Calculating the number (n) of the futures to trade. NV01 of $1,000,000 three month deposit is $25. PV01 of future is $25 (0.25*1,000,000*0.0001)

25, 000, 000 25 n! * ! 25 1, 000, 000 25

Short Term Interest Rate Futures


Calculating the effectiveness of the futures hedge. Assume futures price is 90.65 when the hedge is established Assume three month LIBOR at the reset date is 8.75% pa., that implies a futures price of 91.25. Thus the futures position will pay 60*$25*25=$37,500 in variation margin.

Short Term Interest Rate Futures


Calculating the effectiveness of the futures hedge cont. The roll-over is 0.6% pa lower than the forward rate implied when the hedge was established. The fall in interest revenue on the $25,000,000 90 day deposit is 0.25*0.006*$25,000,000 = $37,500 NB Eurodollar markets assume a 360 day year!

Short Term Interest Rate Futures


Calculating the number (n) of the futures to trade to hedge a six month deposit. NV01 of $1,000,000 six month deposit is $50. PV01 of future is $25

6,000,000 50 n! * ! 12 1,000,000 25

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