Interest Rate Hedges 1 June depositing in 5 months So buy December 19 On 1 June we buy 19 December contracts On 1 November we will sell Price 9660 Basis risk 60 ticks By 1 November basis risk will fall by 57 leaving 17 ID: 646974
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Slide1
Interest Rate Hedges
Mark Fielding-PritchardSlide2
Interest Rate Hedges
1 June, depositing in 5 months
So buy December
= 19On 1 June we buy 19 December contractsOn 1 November we will sellPrice 96.60Basis risk 60 ticksBy 1 November basis risk will fall by 5/7, leaving 17
Slide3
b)
We want an FRA starting in 5 months, ending in 9 months so 5v9
FRA Deposit rates are 3.45%
Future is 96.60 which is 3.4%Examiner has taken into account decline in basis risk, so decline of 43 ticks is a gain, this buying/selling long dated futures and making gains from he narrowing of the spreads is trade practiceSlide4
c)
Interest rates fall 0.5%, from 4 to 3.5%
FRA Payment to bank
7.1m x 0.05% x 4/12 = £1183.33Lost interest 7.1m x 0.5% x 4/1211833Bought Future 9660Sold 10000 – 350 + 17 = 9667
Gain 7 x 12.50 x 19=
1662.50
Net Loss
10170.50Slide5
d)
Basis risk may not decline in a straight line
Payments/ receipts will not occur at the end
Fees & deposits are ignoredBasis of calculations may not be directly inked to LIBORSlide6
e)
Similarities
Hedging instruments
Allows fixing rates over periods of timeCan make floating rate loans fixed and vice versaCan combine with currency DifferencesFRA short term, swap mediumFRAs are usually set up as collars to offset costs