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Interest Rate Risk management

Interest rate futures

4.1 Features

 Two types – short term interest rate futures (STIRs) and long term bond futures.

 In both cases the underlying asset can be viewed as buying or selling bonds

 'Price' = 100 – interest rate.

Size of loan Duration of loan
 Number of contracts = ×
Size of contract Duration of contract

4.2 Futures hedging calculations

1. Now – set up the hedge.

 Buy or sell futures? Borrow = sell, deposit = buy

 Which expiry date? First contract to expire after future transaction

 How many contracts? Look at contract size and duration.

2. Contact the exchange and pay the initial margin.

3. Future transaction date – close out the futures position.

 Buy or sell? e.g. if originally contracted to sell, then close by buying

 Calculate gain or loss.

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