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Hi John,
Today is 1/9, Massie will receive €25m on 30/11. It worries about the interest rate during this 3 months time, after 30/11, €25m has been invested, so no matter how the interest moves. the contract size should be 25/1X3mth time/3mth future=25 contracts. Why examiner has 50 contracts? Doesn’t Massie only hedge for 3 months?
Thanks for you help.
The money will be invested for 6 months and therefore we need to cover 6 months interest.
The futures are always 3 month futures and so only cover for 3 months interest. To cover for 6 months we need to multiply by 6/3.
I do suggest you watch the free lectures on interest rate risk management, because I explain all this in the lectures.
Thansk John,
I did watch your lecture, but I thought we are hedging for the period from 1/9 to 30/11. Once the investement is made, the movement of interest rate is inrelevant as the rate is fixed unless the investment is on floating rate which is not told in the question. becasue from 1/9 to 30/11 is 3 months, wich is the same period as futures contract. I thought we only need to buy 25 contrats instead 50. Do you think we are hedging for period from 30/11 to 31/5?
You really need to watch the lecture again, because you are misunderstanding one of the most important points of all.
Once the deposit starts, the interest is indeed fixed, but it applies for the whole period of the deposit which is 6 months.
Using futures is hedging against interest changes between now and the start of the deposit. However the calculation of the gain or loss is only done as though it is three months interest (because they are always 3 months futures). To protect against six months interest we therefore need to deal in twice as many 3 months futures.
I do explain this point in detail in the lectures, because again it is fundamental to understanding how interest rate futures are used.
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