What is a short-term interest rate future?
Short-term interest rate futures have an underlying instrument with a maturity of less than one year, while long-term interest rate futures have an underlying instrument with a maturity of over one year.
How does interest rate affect futures price?
The futures price decreases when there is a known interest income because the long side buying the futures does not own the asset and, thus, loses the interest benefit. Otherwise, the buyer would receive interest if they owned the asset. In the case of stock, the long side loses the opportunity to get dividends.
How do you find theoretical futures price?
Key takeaways from this chapter
- The futures pricing formula states that the Futures Price = Spot price *(1+Rf (x/365)) – d.
- The difference between futures and spot is called the basis or simply the spread.
- The futures price as estimated by the pricing formula is called the “Theoretical fair value”
What is interest rate futures contract?
An Interest Rate Futures contract is “an agreement to buy or sell a debt instrument at a specified future date at a price that is fixed today.” The underlying security for Interest Rate Futures is either Government Bond or T-Bill.
What is the difference between FRA and futures?
A forward contract is a private and customizable agreement that settles at the end of the agreement and is traded over the counter. A futures contract has standardized terms and is traded on an exchange, where prices are settled on a daily basis until the end of the contract.
What are Euribor futures?
Eurodollar futures are a LIBOR-based derivative, reflecting the London Interbank Offered Rate for a 3-month $1 million offshore deposit. Eurodollar futures prices are expressed numerically using 100 minus the implied 3-month U.S. dollar LIBOR interest rate.
How does a FRA work?
An FRA is an agreement to borrow or lend a notional cash sum for a period of time lasting up to twelve months, starting at any point over the next twelve months, at an agreed rate of interest (the FRA rate). The “buyer” of an FRA is borrowing a notional sum of money while the “seller” is lending this cash sum.
How do you hedge interest rate futures?
The approach used with futures to hedge interest rates depends on two parallel transactions:
- Borrow/deposit at the market rates.
- Buy and sell futures in such a way that any gain that the profit or loss on the futures deals compensates for the loss or gain on the interest payments.
Why are interest rate futures relatively unpopular among financial managers?
Interest rate futures are relatively unpopular among financial managers because of their relative illiquidity and their difficulty of use. Some of the world’s largest and most financially sound firms may borrow at variable rates less than LIBOR. The current one-year rate is 5%.
What is the purpose of interest rate swaps?
Interest rate swaps usually involve the exchange of a fixed interest rate for a floating rate, or vice versa, to reduce or increase exposure to fluctuations in interest rates or to obtain a marginally lower interest rate than would have been possible without the swap.
Why are futures prices higher than spot prices?
The futures market exists because producers want the safety that comes with locking in a reasonable price in advance, while futures buyers are hoping that the market value of their purchase rises during the interim before delivery. When the futures price is higher than the spot price, it is known as contango.
What causes futures to go up?
Index Futures Predict the Opening Direction If they buy index futures, the price will go up. And with index arbitrageurs on the sidelines until the U.S. stock market opens, nobody will counteract the buying pressure even if the futures price exceeds fair value.