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Interest Rate Risk management

Example 3

(ii) Gain or loss

Initially: sold @ 96.5

Close out: buy @ 95%

Gain of 1.5%

£500,000 × 24 × 3/12 × 0.015 = £45,000

Close out

Expected interest cost is 100 – 96.5 = 3.5%:

£6,000,000 × 0.035 × 6/12 = £105,000

If interest rates rise to 5%, the cost will be:

£6,000,000 × 0.05 × 6/12 = £150,000

This is an increase in cost of £45,000.

This is netted off by the gain when the futures position is closed out.

Note: a question this detailed is unlikely but it shows the various stages which
could all be tested individually.

Illustrations and further practice

Now try TYU 4 and 5 in Chapter 13

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