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Answers to examples

Example 3

At the end of June X6, J plc decides to borrow £6,000,000 in Sept X6 for six
months. The treasurer is concerned that interest rates will rise in the
intervening period and notes that 3 month September sterling interest rate
futures are trading at 96.5. A standard contract size is £500,000

The refundable margin of the futures contracts is 0.5%.

(i) Set up the hedge.

(ii) On 30 September, interest had risen to 5%. Show the hedge would
be closed out.

Solution

(i) Buy

Borrowing we need to be in a position to benefit if rates go up. The
current price is 100 – 3.5 = 96.5, if rates go up the price will fall, so we
sell now.

Contract expiry

First month after transaction is due, Sept X6

How many contracts?

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

= (6,000,000/500,000) × (6 months/3 months)

= 12 × 2

= 24

Pay margin

24 contracts × £500,000 × 0.5% = £60,000

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