Interest Rate Futures

CHAPTER 7
INTEREST RATE FUTURES

In this chapter, we explore one of the most successful
innovations in the history of futures markets; that is,
interest rate futures contracts. This chapter is organized
into the following sections:
1. Interest Rate Futures Contracts
2. Pricing Interest Rate Futures Contracts
3. Speculating With Interest Rate Futures Contracts
4. Hedging With Interest Rate Futures Contracts
Chapter 7
Interest Rate Futures Introduction

Interest rate futures contracts are one of the most
successful innovations in futures trading.
Pioneered in the United States, they have expanded
internationally with strong presence in Great Britain and
Singapore.
The CBOT specializes in contracts with long-term maturity
(e.g., 2-year, 5-year and 10-year T-notes, and 5-year
LIBOR-based swaps).
The CME International Monetary Market (IMM) specializes
in contracts with short-term maturity (e.g., 1-month, and 3month Eurodollar deposits).
Chapter 7
Short-Term Interest Rates Contracts

In this section, four short-term interest rate futures
contracts will be examined:
1. Eurodollar Futures
2. Euribor Futures
3. TIEE 28 Futures
4. Treasury Bill Futures
Chapter 7
Eurodollar Futures Product Profile
Chapter 7
Eurodollar Futures
1. Eurodollar futures currently dominate the U.S. market
for short-term futures contracts.
2. Rates on Eurodollar deposits are usually based on
LIBOR (London Interbank Offer Rate).
LIBOR is the rate at which banks are willing to lend funds
to other banks in the interbank market.
3. Eurodollars are U.S. dollar denominated deposits held

in a commercial bank outside the U.S.
4. The Eurodollar contracts is for $1,000,000.
5. A Eurodollar futures contract is based on a time deposit
held in a commercial bank (e.g., 3-month Eurodollar)
6. Eurodollar contracts are non-transferable.
Chapter 7
Eurodollar Futures
7. Eurodollar futures were the first contract to use cash
settlement rather than delivery of an actual good for
contract fulfillment.
8. To establish the settlement rate at the close of trading,
the IMM determines the three-month LIBOR rate.
9. This settlement rate is then used to compute the
amount of the cash payment that must be made.
10. The yield on the Eurodollar contract is quoted on an
add-on basis as follows:
Chapter 7
Eurodollar Add-on Yield
Add onYield
$ Discount
Price
)( )
360
DTM
In order to calculate the add-on yield, the price and

discount must be computed as follows:
$ Discount
DY ( Face Value )( DTM )

360
Price Face Value $ Discount

Or equivalently
Price Face Value

360
Chapter 7

Suppose you have a 90-day Eurodollar deposit with a
discount yield of 8.32%.
Step 1: Compute the discount and the price.
Price Face Value
Price 1,000,000

360
0.0832(1,000,000 )(90)
360
Price 1,000,000 20,800

Price $979,200
$Discount $20,800
Chapter 7

Step 2: Compute the add-on yield using:
Add onYield
360
($Discount
)(
)
Price
DTM
Add onYield
$20,800 360
(979
)( 90 )
,200
Add onYield 0.085
A one basis point change in the Add-on Yield, on a 3-month

Eurodollar contract implies a $25 change in price. This
amount can be compute using:
Face Value Add on Yield DTM 360
$1,000,000 .0001 90 360 $25
Eurodollar futures contract prices are quoted using the

IMM Index which is a function of the 3-month LIBOR rate:
IMM Index = 100.00 - 3-Month LIBOR
Chapter 7
Euribor Futures
Euribors are Eurodollar time deposits.
Swaps dealers use Euribor futures to hedge the risk
resulting from their activities.
Euribor futures are traded at:
Euronex.liffe
Contracts are based on a 3-month time deposit with a
1,000,000 notional value.
Contracts are cash settled at expiration .
Eurex
Contracts are based on a 3-month time deposit with a
3,000,000 notional value.
Contracts are cash-settled at expiration.
Chapter 7
10
Euribor Futures Product Profile
Chapter 7
11
TIEE 28 Futures
The TIEE 28 futures contract is based on the short-term
(28-day) Mexican interest rate.
The contract is traded on the Mexican Derivatives
Exchange (Mercado Mexicano de Derivados, or MexDer)
A 28-day TIIE futures contract has a face value of 100,000
Mexican pesos.
The contract is cash settled based on the 28-day Interbank
Equilibrium Interest Rate (TIIE), calculated by Banco de
Mxico.
Chapter 7
12
TIEE 28 Futures TIEE 28 Futures
Chapter 7
13
Treasury Bill Futures

1. A T-bill is the U.S. government borrowing money for a
short period of time.
Treasury bills have original maturities of 13 weeks and 26
weeks.
2. The Treasury bill futures contract calls for the delivery

of T-bills having a face value of $1,000,000 and a time
to maturity of 90 days at the expiration of the futures
contract.
91-day and 92 day T-bills may also be delivered with a
price adjustment.
The contracts have delivery dates in March, June,
September, and December.
The delivery dates are chosen to make newly issued 13
week T-bills immediately deliverable against the futures
contract.
Chapter 7
14

Price quotations for T-bill futures use the International
Monetary Market Index (IMM).
IMM Index = 100 - DY
Where:
DY = Discount Yield
Example
A discount Yield of 7.1% implies an IMM Index of:
IMM Index = 100 - 7.1
IMM Index = 92.9
Chapter 7
15

Recall that a bill with 90 days to maturity and a 8.32%
discount yield, has a price of $979,200 and a $discount of
$20,800. For a futures contract with a discount yield of
8.32%, the price to be paid for the T-bill at delivery would
be $979,200.
A one basis point shift implies a $25 change on a
$1,000,000, 3-month futures contract.
If the futures yield rose to 8.35%, the delivery price would
be $979,125.
Chapter 7
16
Other Short-Term Interest Rate Futures

Insert Figure 7.1 here
Chapter 7
17
Longer-Maturity Interest Rate Futures

Longer-maturity interest rate futures are based on couponbearing debt instruments as the underlying good.
These instruments require the delivery of an actual bond.
In this section, long-term interest rate futures contracts will
be examined, including:
1. Treasury Bond Futures
2. Treasury Note Futures
3. Non-US Longer Maturity Interest Rate Futures
Chapter 7
18
Treasury Bond Futures

Traded at the CBOT, the Treasury bond futures contract is
one of the most successful futures contracts.
Requires the delivery of T-bonds with a $100,000 face
value and with at least 15 years remaining until maturity or
until their first permissible call date.
T-bond contracts trade for delivery in March, June,
September, and December.
Delivery against the T-bond contract is a several day
process that the short trader can trigger to cause delivery
on any business day of the delivery month.
First Position Day
First permissible day for the short to declare his/her intentions to
make delivery, with delivery taking place 2 business days later.
Position Day
Short declares his/her intentions to make delivery. This may
occur on the first position day or some other later day.
Delivery Day
Clearinghouse matches the short and long traders and requires
them to fulfill their responsibilities.
Chapter 7
19
Treasury Bond Futures

Price Quotation for Major Interest Rate Futures
Contracts
Insert Figure 7.1 Here
Chapter 7
20
Treasury Bond Futures Delivery Process

Chapter 7
21
Treasury Bond Futures Product Profile
Chapter 7
22
Treasury Bond Futures Conversion

Factor
The T-bond contract does not specify exactly which bond
must be delivered to fulfill the futures contract. Rather, a
number of different bonds can be delivered to fulfill the
futures contract.
Because the short trader chooses whether to make delivery,
and which bond to deliver, the short trader will want to
deliver the bond that is least expensive for him/her to obtain.
This bond is called the cheapest-to-deliver bond.
To address this issue, a conversion factor is computed to
equate the bonds.
Chapter 7
23

Factor
Invoice Amount DSP ($100,000)(CF ) AI
Where:
DSP = Decimal Settlement Price
(The decimal equivalent of the quoted price)
CF =
Conversion Factor
(the conversion factor as provided by the CBOT)
AI = Accrued Interest
(Interest that has accrued since the last coupon payment on
the bond)
This system is effective as long as the term structure of

interest rates is flat and the bond yield is 6%. However, if
the term structure of interest rates is not flat, or if bond yields
are not 6%, some bonds will still be less expensive to deliver
against the futures contract than others.
Chapter 7
24
T-Bond and T-Notes Delivery Sequence

Table 7.1 shows key dates in the delivery process for Tbond and T-note futures contracts in 1997.
Chapter 7
25

Factor
Chapter 7
26
Treasury Note Futures

Treasury note futures are a shorter maturity version of a
Treasury bond.
T-note Futures are very similar to Treasury bond
futures.
T-note futures contracts are available for 2-year, 5-year,
and 10-year maturities.
Contract Size
2-year contract
$200,000
5-year & 10 year contract $100,000

Deliverable Maturities
2-year contract
21 -24 month
5-year contract
4 yrs 3 mos. to 5 yrs 3 mos.
10-year contract
6 yrs 6 mos. to 10 years
Chapter 7
27
CBOTs 10-Year Treasury Note Futures

Product Profile
Chapter 7
28
Non-US Long Maturity Interest Rate

Futures
Chapter 7
29
Pricing Interest Rate Futures Contracts

Because, interest rate futures trade in a full carry market,
the foundation for pricing interest rate futures is the Costof-Carry-Model that we discussed in Chapter 3.
This section introduces a review of the Cost-of-Carry
Model as discussed in Chapter 3, including:
1. Cost-of-Carry Rule 3
2. Cost-of-Carry Rule 6
3. Features that Promote Full Carry
4. Repo Rates
5. Cost-of-Carry Model in Perfect Market
6. Cash-and-Carry Arbitrage for Interest Rate Futures
Chapter 7
30
Cost-of-Carry Rule 3
Recall: the cost-of-carry rule #3 says:
F 0, t S 0(1 C 0, t )
Where:
S0 =
The current spot price
F0,t =
The current futures price for delivery of the

product at time t
C0,t=
The percentage cost required to store (or carry)

the commodity from today until time t
Chapter 7
31
Cost-of-Carry Rule 6
Recall: the cost-of-carry rule #6 says:
F 0, d F 0, n (1 Cn , d )
F0,d =
the futures price at t=0 for the the distant delivery

contract maturing at t=d
Fo,n=
the futures price at t=0 for the nearby delivery

contract maturing at t=n
Cn,d=
the percentage cost of carrying the good from t=n

to t=d
Chapter 7
32
Full Carry Features

Recall from Chapter 3 that there are five features that
promote full carry:
1. Ease of Short Selling
2. Large Supply
3. Non-Seasonal Production
4. Non-Seasonal Consumption
5. High Storability
Interest rates futures have each of these features and thus
conform well to the Cost-of-Carry Model.
Chapter 7
33
Repo Rate
Recall from Chapter 3 that if we assume that the only
carrying cost is the financing cost, we can compute the
implied repo rate as:
F 0, t
1 C 0, t
S0
or
F 0, t
1 C 0, t
S0
Interest rate futures conform almost perfectly to the Costof-Carry Model. However, we must take into account
some of the peculiar aspects of debt instruments.
Chapter 7
34
Cost-of-Carry Model in Perfect Market

Assumptions
1. Markets are perfect.
2. The financing cost is the only cost of carrying charge.
3. Ignore the options that the seller may possess such as
the option to deliver differing securities.
4. Ignore the differences between forward and futures
prices.
Chapter 7
35
Cash-and-Carry Arbitrage for Interest

Rate Futures
Recall from Chapter 3 that in order to earn an arbitrage
profit, a trader might want to try a cash-and-carry arbitrage.
Recall further that a cash-and-carry arbitrage involves
selling a futures contract, buying the commodity and
storing it until the futures delivery date. Then you would
deliver the commodity against the futures contract.
Applying the cash-and-carry arbitrage to interest rate
futures requires careful selection of the commoditys
interest rate (T-bill, T-bond etc) that will be purchased.
Each of the interest rate futures contracts specifies the
maturity of the interest rate instrument to be delivered. The
interest rate instrument must have this maturity on the
delivery date.
Chapter 7
36

Rate Futures
Example, a T-bill futures contract requires the delivery of a
T-bill with 90 days to maturity on the delivery date.
So, if you sell a T-bill futures contract that calls for delivery
in 77 days, we must purchase a T-bill that will have 90 days
to maturity, 77 days from today, in order to meet your
obligations. That is, you must purchase a T-bill that has
167 days to maturity today.
77
1. Sell futures
Contract.
2. Buy T-bill Futures
contract w/ 167
days to maturity.
167
3. Deliver T-bill (that has

now 90 days to maturity)
against futures contract.
4. T-bill
matures
Table 7.2 and 7.3 further develop this example.
Chapter 7
37

Rate Futures
Assume that markets are perfect including the assumption
of borrowing and lending at a risk-less rate represented by
the T-bill yields. Suppose that you have gathered the
information in Table 7.2 and wish to determine if an
arbitrage opportunity is present.
How was the bill price of $987,167 from Table 7.2

calculated?
Chapter 7
38

Rate Futures
The bill prices were calculated as follows:
Bill Price Face Value

360
For the March Futures Contract

Bill Price 1,000,000
0.125(1,000,000)(90)
360
Bill Price 968,750
For the March 167-day T-bill

0.10(1,000,000)(167)
360
Bill Price 953,611
For the 77-day T-bill with $1,000,000 face value

0.06(1,000,000)(77)
360
Bill Price 987,166
Chapter 7
39

Rate Futures
The transactions necessary to earn an arbitrage profit are
given in Table 7.3.
How was the $966,008 from Table 7.3 calculated?
Chapter 7
40

Rate Futures
The $966,008 is the face value of a 77-day T-bill with a
current price of $953,611. To calculate this value,
rearrange the bill price formula:

360
Rearranging the equation results:

Face Value
360 Bill Price

360 DY ( DTM )
Face Value
360($953,611)
360 0.06(77)
Face Value
343,299,960
355.38
Face Value 966,008.10
Chapter 7
41
Cash-and-Carry Arbitrage to Interest

Rate Futures
When delivery is due on the futures contract on March 22,
you deliver the T-bill (which now has 90 days to maturity)
against the futures contract.
Combined, these transactions appear as follows on a

timeline:
0
1. Borrow money
2. Buy 167-day T-bill
3. Sell a futures contract
4. Deliver the T-bill

against the futures
contract
5. Pay off the loan
Chapter 7
42
Reverse Cash-and-Carry Arbitrage to

Interest Rate Futures
Using the same values as shown in Table 7.2, now assume
that the rate on the 77-day T-bill is 8%.
Given this new information and Table 7.2 prices, a reverse
cash-and-carry arbitrage opportunity is present. Table 7.4
shows the result.
To calculate the values in Table 7.4 follow the steps shown
for the previous cash-and-carry example.
Chapter 7
43
Reverse Cash-and-Carry Arbitrage to

Interest Rate Futures
Combined, these transactions appear as follows on a
timeline:
Jan 5
1. Borrow money
3. Buy a futures
contract
Mar 22
4. Collect from maturing T-bill

5. Accept delivery on 90-day
contract
Chapter 7
Jun 20
6. Collect 1 M
from mature
T-bill
7. Pay off loan
44
Interest Rate Futures Rate Relationships

Rate relationship that must exist between interest rates to
avoid arbitrage:
Consider two methods of holding a T-bill for 167 days.
Method 1:
Buy a 167 day T-bill
Method 2:
Buy a 77 day T-bill.
Buy a futures contract for delivery of a 90 day T-bill in 77
days.
Use the futures contract to buy a 90-day T-bill.
These investment appear as follows on a timeline.
Chapter 7
45
Interest Rate Futures Rate Relationships

Method 1
Jan 5
Mar 22
Jun 20
2. Collect from maturing T-bill
Method 2
Jan 5

2. Buy a future
contract for 90-day
T-bill w/ 77 days to
maturity
Mar 22
Jun 20
3. Collect from maturing

T-bill
4. Buy a 90-day T-bill using
the futures contract
5. Collect from
maturing
T-bill
Either of these two methods of investing in T-bills has

exactly the same investment and exactly the same risk.
Since both investment have exactly the same risk and
exactly the same investment, they must have exactly the
same yield to avoid arbitrage.
Chapter 7
46
Financing Cost and Implied Repo Rate

Calculate the rate that must exist on the 77-day T-bill to
avoid the arbitrage as follows:
Use the no arbitrage equation to determine the appropriate

yield on the 77-day T-bill by, using the following equation:
NA Yield
Price of Futures Contract Long Term T Bill Price

DTMFC
Price of Futures Contract X
360
Where:
NA Yield = the no arbitrage Yield
DTMFC = days to maturity of the futures contract
Chapter 7
47
NA Yield
NA Yield
$968,750 953,611
77
$968,750 X
360
$15,139
$207,204.86
NA Yield 0.07306
So in order for there to be no arbitrage opportunities

available, the yield on the 77 day T-bill must be 7.3063%.
If the yield on the 77 day T-bill is greater than 7.3063%,
then engage in a reverse cash-and-carry arbitrage. If the
yield on the 77 day T-bill is less than 7.3063%, engage in
a cash-and-carry arbitrage.
Chapter 7
48

We can also calculate the implied repo rate as follows:
F 0, t
1 C 0, t
S0
In our case the spot price is the price of the 167-day to
maturity T-bill, so:
$968,750
1 C 0, t
$953,611
1 C 0, t 1.015875
The implied repo rate (C) is 1.5875%

The implied repo rate is the cost of holding the
commodity for 77 days, between today and the time that
the futures contract matures, assuming this is the only
financing cost, it is also the cost of carry.
Chapter 7
49

1. If the implied repo rate exceeds the financing cost, then
exploit a cash-and-carry arbitrage opportunity
Borrow funds
Buy cash bond
Sell futures
Realize profit
Deliver against
futures
Hold bond
2. If the implied repo rate is less than the financing

cost, then exploit a reverse cash-and-carry
arbitrage.
Buy futures
Sell bond short
Invest proceeds
until futures exp.
Realize profit
Repay short sale

obligation
Take delivery
Chapter 7
50
Cost-of-Carry Model for T-Bond Futures

The cost of carry concepts for T-bill futures that we have
just examined also apply to T-bond futures. However, the
computation must be adjusted to reflect the coupon
payment and accrued interests.
Chapter 7
51
Cost-of-Carry Model in Imperfect

Markets
In this section, the borrowing and lending assumptions are
relaxed, and the Cost-of-Carry Model is explored under the
following assumption:
1. The borrowing rate exceeds the lending rate.
2. The financing cost is the only carrying charge.
3. Ignore the options that the seller may possess.
4. Ignore the differences between forward and
futures prices.
Recall that allowing the borrowing and lending rates to
differ leads to an arbitrage band around the futures price.
Now assume that the borrowing rate is 25 basis points, or
one-fourth of a percentage point, higher than the lending
rate. Continuing to use our T-bill example.
Chapter 7
52
Cash-and-Carry Strategy
Notice that the entire arbitrage profit disappears

when these differential borrowing and lending
rates are considered.
Chapter 7
53
Reserve Cash-and-Carry Transaction
Again notice that the entire arbitrage profit disappears

when these different borrowing and lending rates are
considered.
Chapter 7
54
A Practical Survey of Interest Rate

Futures Pricing
Recall from Chapter 3 that transaction costs lead to a noarbitrage band of possible futures prices. In essence,
transaction costs increase the no-arbitrage band just as
unequal borrowing and lending rates do.
Impediments to short selling as a market imperfection
would frustrate the reverse cash-and-carry arbitrage
strategy.
From a practical perspective, restrictions on short selling
are unimportant in interest rate futures pricing because:
Supplies of deliverable Treasury securities are plentiful
and government securities have little (or zero)
convenience yield.
Treasury securities are so widely held, many traders can
simulate short selling by selling T-bills, T-notes, or T-bonds
from inventory. Therefore, restrictions on short selling are
unlikely to have any pricing effect.
Chapter 7
55
Speculating with Interest Rate Futures

There are several ways that you can speculate with interest
rate futures:
1. Outright Position.
2. Intra-Commodity T-Bill Spread
3. A T-bill/Eurodollar (TED) Spread
4. Notes over Bonds (NOB)
Chapter 7
56
Speculating with Outright Position

Two ways to speculate with outright positions are:
1. Purchase an interest rate futures contract: a bet that
interest rates will go down.
2. Sell an interest rate futures contract: a bet that interest
rates will go up.
Suppose you think that interest rates will go up.
The transactions necessary to bet on your hunch are
outlined in Table 7.80.
Chapter 7
57
Speculating with Outright Position

Interest rates have gone up as you predicted. Your profit
(based on $25 per basis point contract) is:
Profit = (Sell Rate Buy Rate)($25)
Profit = (90.30 90.12) = 0.18
0.18 is 18 basis points, each of which implies a $25 change
in contract value so:
Profit = (Basis Points)(Value per Basis Point)
Profit = (18)($25) = $450
Chapter 7
58
Intra-Commodity T-Bill Spread

If you dont know if rates will rise or fall, but do think that
the shape of the yield curve will change, (that is the
relationship between short term interest rates and long
term interest rates will change) you might engage in an
Intra-commodity T-bill spread.
If you think that the spread will narrow (the yield curve will
become flatter) you would buy the longer term contract and
sell the shorter term contract.
If you think that the spread will widen (the yield curve will
become steeper), you would buy the shorter term contract
and sell the longer term contract.
Chapter 7
59

Suppose you have the following information (Table 7.9)
regarding T-bills and T-bill futures contracts for March 20.
The left 2 columns are T-bills, and the right 3 columns are
futures contracts. You think that the yield curve will flatten
and wish to trade to make a profit.
Chapter 7
60

Notice that the T-bills exhibit an upward sloping yield curve.
Notice that the futures contract yields also exhibit and
upward sloping yield curve.
If the yield curve flattens, the yield spread between
subsequent maturing futures contracts must narrow. That
is, the difference between the yield on the December
contract and on the September contract must narrow.
Since you think that the spread will narrow (the yield curve
will become flatter) you would buy the longer term contract
and sell the shorter term contract, as it is demonstrated in
Table 7.10.
Chapter 7
61
Gain in Basis Points

Change in December Contract
Change in September Contract
1.64
-1.52
Net Change in Positions
12 basis points
Each Basis Point is worth $25

Profit
Net Change in Positions
Basis Point Value
Profit
12
$25
$300
Chapter 7
62
T-Bill/Eurodollar (TED) Spread

The TED spread is the spread between Treasury bill
contracts and Eurodollar contracts.
In theory, Treasury bills should always have a lower yield
than Eurodollar deposits.
T-bills are backed by the full taxing authority of the U.S.
government.
Eurodollar deposits are generally not backed by the
respective governments.
Thus, T-bills are a safer investment and as such, should

pay a lower interest rate. Eurodollars are riskier and
should pay a higher rate of interest.
How much lower/higher?
The amount of the difference depends upon world events.
To the extent that the world situation is considered safe,
the difference should be low. To the extent that the world
situation is unsafe, the difference should be high.
Table 7.11 shows the transactions necessary to engage in
a TED spread when you wish to bet that the spread will
widen.
Chapter 7
63
T-Bill/Eurodollar (TED) Spread
Notice that the spread widened as the trader

expected, allowing him/her to earn a $675 profit.
Chapter 7
64
Notes over Bonds (NOB)

The NOB is a speculative strategy for trading T-note
futures against T-bond futures.
NOB spreads exploit the fact that T-bonds underlying the Tbond futures contract have a longer duration than the Tnotes underlying the T-note futures contract. A given
change in yields will cause a greater price reaction for the
T-bond futures contract.
Thus, the NOB spread is an attempt to take advantage of
either changing levels of yields or a changing yield curve
by using an inter-market spread.
Chapter 7
65
Hedging with Interest Rate Futures

There are several ways that you can hedge with interest
rate futures, including:
1. Long Hedges
2. Short Hedges
3. Cross-Hedges
Chapter 7
66
Hedging with Interest Rate Futures

Recall that the goal of a hedger is to reduce risk, not to
generate profits.
Using interest rate futures to hedge involves taking a
futures position that will generate a gain to offset a
potential loss in the cash market.
This also implies that a hedger takes a futures position that
will generate a loss to offset a potential gain in the cash
market.
Chapter 7
67
Long Hedges
On December 15, a portfolio manager learns that he will
have $970,000 to invest in 90-day T-bills six months from
now, on June 15. Current yields on T-bills stand at 12%
and the yield curve is flat, so forward rates are all 12% as
well. The manager finds the 12% rate attractive and
decides to lock it in by going long in a T-bill futures contract
maturing on June 15, exactly when the funds come
available for investment as Table 7.12 shows:
Chapter 7
68
Long Hedges
With current and forward yields on T-bills at 12 percent,
the portfolio manager expects to be able to buy
$1,000,000 face -value of T-bills for $970,000 because:

360
Bill Price $1,000,000
0.12($1,000,000)(90)
360
Bill Price $970,000
On June 15, the 90-day T-bill yield has fallen to 10%.

Thus, the price of a 90 day T-bill is:

360
Bill Price $1,000,000
0.10($1,000,000)(90)
360
Bill Price $975,000
Thus, if the manager were to purchase the T-bill in

the market, he would be $5,000 short.
Chapter 7
69
Long Hedges
The futures profit exactly offsets the cash market loss for a
zero change in wealth. With the receipt of the $970,000
that was to be invested, plus the $5,000 futures profit, the
original plan may be executed, and the portfolio manager
purchases $1,000,000 face value in 90-day T-bills.

The idealized yield Curve Shit for the long Hedge.
Chapter 7
70
Short Hedge
Banks may wish to hedge their interest rate positions to
lock in profits. Table 7.13 demonstrates how a bank that
makes a one million dollar fixed rate loan for 9 months,
and can only finance the loan with 6-month CDs, can
hedged its position.
Because the bank hedged, its profits were not affected

by a change in interest rates.
Chapter 7
71
Cross-Hedge
Recall that a cross-hedge occurs when the hedged and
hedging instruments differ with respect to:
1. Risk level
2. Coupon
3. Maturity
4. Or the time span covered by the instrument being
hedged and the instrument deliverable against the
futures contract.
To illustrate how a cross-hedge is conducted, assume that
a large furniture manufacturer has decided to issue one
billion 90-day commercial paper in 3 months. Table 7.14
illustrate the cross-hedge.
Chapter 7
72
Cross-Hedge
Chapter 7
73

Interest Rate Futures

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Interest Rate Futures

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CHAPTER 7

INTEREST RATE FUTURES

Interest Rate Futures Introduction

Short-Term Interest Rates Contracts

Eurodollar Futures Product Profile

3. Eurodollars are U.S. dollar denominated deposits held

Eurodollar Add-on Yield

In order to calculate the add-on yield, the price and

DY ( Face Value )( DTM )

Price Face Value $ Discount

DY ( Face Value )( DTM )

Eurodollar Add-on Yield

DY ( Face Value )( DTM )

Price 1,000,000 20,800

Eurodollar Add-on Yield

Add onYield 0.085

A one basis point change in the Add-on Yield, on a 3-month

Eurodollar futures contract prices are quoted using the

Euribor Futures Product Profile

TIEE 28 Futures TIEE 28 Futures

Treasury Bill Futures

2. The Treasury bill futures contract calls for the delivery

Treasury Bill Futures

Treasury Bill Futures

Other Short-Term Interest Rate Futures

Longer-Maturity Interest Rate Futures

Treasury Bond Futures

Treasury Bond Futures

Treasury Bond Futures Delivery Process

Treasury Bond Futures Product Profile

Treasury Bond Futures Conversion

Treasury Bond Futures Conversion

This system is effective as long as the term structure of

T-Bond and T-Notes Delivery Sequence

Treasury Bond Futures Conversion

Treasury Note Futures

5-year & 10 year contract $100,000

4 yrs 3 mos. to 5 yrs 3 mos.

6 yrs 6 mos. to 10 years

CBOTs 10-Year Treasury Note Futures

Non-US Long Maturity Interest Rate

Pricing Interest Rate Futures Contracts

The current spot price

The current futures price for delivery of the

The percentage cost required to store (or carry)

the futures price at t=0 for the the distant delivery

the futures price at t=0 for the nearby delivery

the percentage cost of carrying the good from t=n

Full Carry Features

Cost-of-Carry Model in Perfect Market

Cash-and-Carry Arbitrage for Interest

Cash-and-Carry Arbitrage for Interest

3. Deliver T-bill (that has

Table 7.2 and 7.3 further develop this example.

Cash-and-Carry Arbitrage for Interest

How was the bill price of $987,167 from Table 7.2

Cash-and-Carry Arbitrage for Interest

DY ( Face Value )( DTM )

For the March Futures Contract

Bill Price 968,750

For the March 167-day T-bill

Bill Price 953,611

For the 77-day T-bill with $1,000,000 face value