ANSWERS TO More questions on interest rate futures:
• When the US central bank changes the fed funds target rate to alter monetary policy what rates do they influence the most ? (usually)
• Short maturity rates
• Medium maturity rates
• Long maturity rates
Fed policy typically changes overnight rates (one day loans) which impact shorter maturity loans
• If there is a prolonged period of monetary easing of credit i.e. lowering of official interest rates, what impact would you expect it to have on the yield curve?
• Flattens
• Steepens
• Stays the same
Fed easing lowers short rates more than long rates leading to a steeper curve
• Which of the following might be a reason for a negative sloped curve from 2 years to 30 years?
• Monetary conditions have been tightened
• Demand outstrips supply of long dated bonds
• The market expects the next move in rates to be down
• All of the above
• If my bond portfolio has a duration of 5 years and I hedge the market risk by selling 10 year futures, which of the following are true?
• I have immunised my portfolio from market risk ………….FALSE, IMMUNISATION MATCHES DURATION OF ASSETS AND LIABILITIES
• I have a curve risk of a flattening curve ………….YES TRUE, A FLATTENING CURVE WILL COST MONEY BECAUSE THE LONG POSITION IN 5 YEARS WILL LOSE MORE THAN THE HEDGE
• I have curve risk of a steepening curve……NO BECAUSE STEEPENING CURVE WOULD BE PROFITABLE
• I have curve and market risk still …………NO BECAUSE MARKET RISK IS LARGELY HEDGED, BUT THERE IS CURVE RISK (SEE ABOVE)
• If I hedge a $100mm loan exactly in Eurodollar futures when they are trading at 99.50 and I take the position into expiry and the contract settles at 99.75; how much have I made or lost on my hedge?
• $62,500 loss
• $25,000 loss
• $62,500 gain
To hedge a loan, sell eurodollar futures (protects against higher rates)
25bps*25bp value*100 contracts=62500
• I sell 100 classic T-Bond futures at 122-24 and buy them back at 120-08. What is my profit or loss?
• $150,000 gain
• $675,000 gain
• $835,078 gain
122-24 is 122 and 24/32nds – minus 120 and 8/32nds = 1 point and 16 / 32nds = 1.5 points = 48/32nds
48/32 * 31.25 * 100 = $150,000 [number of 32nds * 31.25 $value of a tic * no. of contracts
• If I am a market maker in US Treasuries and make a short sale to a customer in the current 10 year treasury note and buy 10 year T note futures as a hedge – am I long or short the 10 year basis?
• Long basis
• Short basis
I am short cash and long futures
• If the basis widens out do I lose or make money on this position?
• Lose money
• Make money
e.g. cash 102-00, futures 100-00
basis is 64/32nds (or 2 points). If basis goes to 74/32nds (widens) then 102-10 cash market and 100-00 still futures (say makes up the 74/32nds ) then lost 10/32nds on cash position.
• Which of the following are reasons why US interest rate futures are extremely popular
(average volumes have been growing for decades)?
• Market participants are more risk averse ………NOT NECESSARILY
• Speculation is actively encouraged ………..NOT REALLY, AND MAYBE NOT RELEVANT?
• Futures are a cheap, efficient and liquid hedging tool
• Regulators insist on hedging strategies using futures ………..NOT TO MY KNOWLEDGE
• Cash market volumes have increased significantly
• Free 0% money (ZIRP) has to find a home somewhere ……..IF TRUE WOULD GO INTO CASH SECURITIES NOT FUTURES (ALTHOUGH THERE IS SOME EVIDENCE THAT GOV’T HANDOUTS IN USA ARE LEADING TO BIG CALL BUYING SPREES IN POPULAR EQUITIES?? E.G. TSLA STOCK
• If you were managing a long-only US credit bond portfolio and needed to hedge the risk of higher interest rates, what derivative would be more appropriate than just selling US interest rate futures?
• Bond options
• Interest rate swaps
• Forward start bonds
IRS is a good hedge for higher rates on a credit portfolio – swapping fixed for floating [see next topic 8]
• Which of the following risks would you be exposed to in a long US credit bonds/short US interest rate futures position?
– curve risk
– basis risk
– market risk
– all of the above
Explain your answer.
CURVE BECAUSE THERE MIGHT NOT BE A PARALLEL SHIFT, BASIS BECAUSE LONG CASH/SHORT FUTURES AND MARKET RISK BECAUSE THE BONDS MAY GO DOWN (SPREAD WIDENING) AND FUTURES NOT MOVE OR COULD GO UP? Last point is called SPREAD RISK.