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Hi John,
Hoping you can explain something for me? I have the Kaplan study text and the illustration makes no sense to me!
(FYI – It is the basis calculation illustration on page 503)Using June interest rate futures to cover risk on borrowings starting 31 May.
Futures contracts set up on 1 January, LIBOR was at 5% and the futures price was 95.48. LIBOR on 31 May is predicted to be 4%. Estimate the closing futures price on 31 May assuming basis risk reduces in a linear manner.I dont understand the following solution:
1 January basis is at 0.48%?
Futures price at 31 May is 96.08?Hoping you can explain?
Many thanks in advance
Have you watched my lecture on here about forecasting futures prices? The method is explained in full in the lecture.
On 1 January, LIBOR is 5%, which is equivalent to a futures price of 95.00.
On 1 January the futures price is 95.48, and so the basis risk (the difference) is 0.48.We assumes that this difference falls linearly to zero by the end of the future. Because it is a June future, it ends on 30 June, which is 6 months away from 1 January.
So….the basis risk will fall by 0.48 / 6 = 0.08 each month.
On 31 May, if LIBOR is 4% then the equivalent futures price would be 96.00
Since 31 May is in 5 months time, the basis risk will have fallen by 5 x 0.08 = 0.40.
This means the basis risk will be 0.48 – 0.40 = 0.08.So….the actual futures price on 31 May will be 96.00 + 0.08 = 96.08
Thank you John. I have not watched that particular lecture. Will do so, but thanks for your explanation anyway, very much appreciated.
Hi
It is chapter 19 in the Course Notes and if you go to the P4 lectures page
(https://opentuition.com/acca/p4/acca-p4-lectures/) you will see that there are 4 lectures on interest rate futures.Hi there,
Can you please explain to me if there is any expired/unexpired basis in the below interest rate futures question. Couldn’t figure it out.
– Company wants to borrow $30Mn in 3 months from now and funding is needed only for
a period of 3 months.
– Now = end of June 2017.
– 3 months US Dollars Futures price : June 2017 96.87 & September 96.79.
– Currently LIBOR is 3% and company can borrow @ LIBOR +0.9%.
– Interest Rates could increase by 0.5% in 3 months from now.
– Derivative contracts will mature at the end of the month.Thanking you in advance.
Given that you will be using September futures, then the basis will be zero as at the date the loan is taken and the futures expire.
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