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Interest rate futures

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA AFM Exams › Interest rate futures

  • This topic has 1 reply, 2 voices, and was last updated 3 years ago by John Moffat.
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  • Author
    Posts
  • August 29, 2021 at 9:38 am #633335
    herocomesalong
    Member
    • Topics: 66
    • Replies: 36
    • ☆☆

    Hello John,

    Hope you are doing well. I have a question on interest rate futures and am unsure of the calculation of futures price at the end of the contract:

    Question:
    RR wishes to hedge against a short-term, fixed interest deposit of GBP 25m for 3 months until 30 June 20X6. It is considering to use LIFFE 3-month sterling interest rate futures (contract size GBP 500,000) to remove interest rate risk between 31 December 20X5 and 31 March 20X6.

    The board expects at 31 December 20X5 that:
    – the short term, fixed interest deposit rate will be 3.75% per annum; and
    – the March 20X6, 3-month sterling interest rate futures contract will be trading at 96.00

    Calculate how the contract will work if interest rates fall by 1% (to 2.75%) between 1 January 20X6 and 31 March 20X6.

    I could understand every part of the answer to the question except for:
    “Assuming that the futures price has converged to equal the spot interest rate at the end of March (ie the futures price moves from 96.00 to 97.25), this will give RR a gain of 1.25%.”

    May I please ask how we can calculate to obtain the futures price of 97.25 at the end of March 20X6?

    Thank you in advance!

    August 29, 2021 at 1:47 pm #633385
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54699
    • ☆☆☆☆☆

    If interest rates fall to 2.75% then the futures price will be 100 – 2.75 = 97.25. Fortunately it is at the end of March and they are March futures, otherwise (as is normally the case) there would be basis risk to consider.

    I do explain this in my free lectures on the management of interest rate risk.

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