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Hello,
I am looking at the calculating expected futures price on 1 Feb 2015.
If the interst rates will go up by 0.5%, then LIBOR is gonna be 3.8%+0.5%=4.3%
The basis on that date is 0.22 as givenMy calculation will give me futures price = 4.3%-0.22 = 4.08% – implied interest rate on futures, or price 95.92.
Or, 100 – (3.8%+0.5%-0.22%)
The answer is 100 – (3.8%+0.5%)-0.22% = 95.48I can see where I am wrong mathematically, but can’t understand why the price is calculated that way… Am I wrong with using basis? Or what?
Thank you in advance,
The way to decide whether to add or subtract the 0.22 is that if the futures price is currently below the equivalent libor then it will always be below (just the difference will get smaller. If, on the other hand the current futures price is higher than the equivalent libor, then it will always be higher.
Thank you for your reply.
But in this scenario we don’t know the current futures price…You are quite right, and it is rather naughty of the examiner.
The current futures price could be higher or lower than the equivalent interest rate (it would depend on what the market as a whole was expecting to happen to interest rates in the future).
The examiner has made an assumption and should have said that. If you had assumed differently and done what you have done, then you would have to be given the marks.
(Just, as always, state your assumption.)Sorry about that.
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