Phobs co(BBp) 12/08

1. The current basis is 94.00 - 93.88 = 0.12 We always assume that the basis falls linearly to zero over the life of the future. The March futures finish in 3 months time at the end of March, they will be closing the futures deal in 2 months time (at the start of the loan). So there will be 1 month left in the future and therefore the basis will be 1/3 x 0.12 = 0.04. So if the interest rate at close out is 7%, then it is equivalent to 93.00 and will a basis of 0.04 it gives a futures price of 93.00 - 0.04 = 92.96. (There is never any need to work in ticks even though it gives the same answer). 2. I don't know what you mean by 'below' calculation. However in calculating the number of contracts needed and in calculating the premium, we always use the length of the loan, which is 4 months. 3. No - the premium is never calculated the way you have written, and the premium on interest rate options is never quoted in cents - it is quoted as an annual percentage. We take what you have written but then multiply by 3/12 (because they are options on 3 months futures). So for 80 March put option contracts at 94.00, the premium is 80 x $500,000 x 0.168/100 x 3/12 = $16,800 I do suggest that you watch our free lectures on interest rate risk management, because all of the above is explained in detail.

Sorry SIR, Yes you are absolutely right I have written the wrong way of premium calculation, premium in interest rate is NOT given in cents, and in your lectures you have divided premium amount by 400 which give the same answer $16800. The calculations of the forecast amount was also simple just like other calculations but i wasnt able to cope in this question. I dont know why i am not focusing question properly. :( Thank You for answering silly question.

Don't worry - there is so much involved that it is easy to get confused :-)

Dear Sir, I understand the first bit of the basis calculation but not the other bit of it i.e. 94.96 calculation. if interest rate falls then the future will increase but why we are deducting (95.00-0.004) rather than adding it. There must be something wrong in my thought procedure I followed your lecture today but still confused

The futures price and the equivalent interest rate will always move closer together over time. (So whichever is lower currently will always be lower, and whichever higher will always be higher)

Thanks, Sir

You are welcome :-)