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Hello Sir, ‘futures market can be used to speculate interest rates’ it is said to be true… but why?Isn’t there basis risk……….
Speculators can buy and sell interest rate futures in the hope of making profits if interest rates move in a direction that is good for them, just as speculators can make profits by buying and selling shares if the share price moves in the right direction.
Financial managers should not use futures to speculate. They use them to hedge the interest rate risk on loans or deposits then are intending to make. The only relevance of basis risk is that when financial managers use futures we assume in our calculations that the basis falls linearly. In practice it does not have to fall linearly and this leaves a bit of risk for the financial manager. This risk is not relevant for speculators.
Sir what do you mean by basis falling linearly? as in the futures price VS actual rates?
Yes. In calculations we assume that the basis falls linearly to zero over the life of the future, whereas in real life it might not fall linearly.
However, don’t worry about this because calculations are not examined in Paper FM – only in Paper AFM.
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