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Interest Rate Futures July 2011 1. Introduction Interest rate Futures Short term interest rate...

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  • Slide 1
  • Interest Rate Futures July 2011 1
  • Slide 2
  • Introduction Interest rate Futures Short term interest rate futures (STIR) Long term interest rate futures (LTIR) 2
  • Slide 3
  • World interest rate contracts 3
  • Slide 4
  • 2010 Break down of interest rate contract volume by product group 4
  • Slide 5
  • Source: FIA Magazine March/April 2011 5
  • Slide 6
  • 6
  • Slide 7
  • 7
  • Slide 8
  • Volume by geographical zone 8
  • Slide 9
  • Principle value of 1 Mil with a three-month maturity Quote : 100 - yield yield = (discount/price)(360/day to maturity) price = 1 mil discount yield(%)*1 Mil*DTM 360 9
  • Slide 10
  • Short term interest rate futures Eurodollar Assume discount yield is 8.32 % with 90 days to maturity what is the price? price = 1 mil discount yield(%)*1 Mil*DTM 360 Price = 1,000,000 - [(.0832*1,000,000*90 )/360] = 979,200 Quotation = 100-.0832 = 91.68 10
  • Slide 11
  • Pricing futures Cost of carry model in perfect market market is perfect financing cost is the only carrying charge ignore the different between forward and futures prices ignore the options the seller may possess 11
  • Slide 12
  • Interest rate futures and arbitrage DTMdiscount yieldFace valuediscountPrice ABCD [B*(A/360)]*CC-D 776% 1,000,000 12,833.33 987,167 16710% 1,000,000 46,388.89 953,611 9012.5% 1,000,000 31,250.00 968,750 167 days 90 days77 days 6% 10% 12.5% Jan 5 Mar 22 12
  • Slide 13
  • Interest rate futures and arbitrage 167 days 90 days77 days 8% 10% 12.5% Jan 5 Mar 22 DTMdiscount yieldFace valuediscountPrice ABCD [B*(A/360)]*CC-D 778% 1,000,000 17,111.11 982,889 16710% 1,000,000 46,388.89 953,611 9012.5% 1,000,000 31,250.00 968,750 13
  • Slide 14
  • Interest rate futures and arbitrage For no arbitrage to happen: Holding 167 days t-bill(10%) must give equal yield to hold 77 days t-bill followed by 90days t-bill (12.5%) from futures delivery Only yield that prevent arbitrage is 953611 = 968750-(96850*(x)*(77/360)) 953611/968750 = 1-(.213889x) X =.73063 DTMdiscount yieldFace valuediscountPrice ABCD [B*(A/360)]*CC-D 776% 1,000,000 12,833.33 987,167 16710% 1,000,000 46,388.89 953,611 9012.5% 1,000,000 31,250.00 968,750 14
  • Slide 15
  • Financing cost and implied repo rate 1+C = 968,750/953611 = 1.015875 DTMdiscount yieldFace valuediscountPrice ABCD [B*(A/360)]*CC-D 776% 1,000,000 12,833.33 987,167 16710% 1,000,000 46,388.89 953,611 9012.5% 1,000,000 31,250.00 968,750 implied repo rate>financing costcash n carry borrow fund buy cash bond, sell futures, hold bond n deliver against futures implied repo rate
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