BBMF2073 FOREX AND DERIVATIVES

Tutorial 7: Interest Rate Futures

Question 1

Suppose today is January 1st and the following rates are quoted in the interbank market:

3-month KLIBOR 5.0% (Maturing; March 30)

6-month KLIBOR 6.5% (Maturing; June 30)

Given the above information, what is the correct price of a 3-month KLIBOR futures contract?

[1 LongRate ( LongTenor / 360)]

[1 IFR (Tenor / 360)]
[1 ShortRate ( ShortTenor / 360)]
1 0.065 (180 / 360)
1 IFR (90 / 360)
1 0.05 (90 / 360)
1 IFR (90 / 360) 1.0198
IFR (1.0198 1) 360 / 90
0.0790 @ 7.90%
Correct price= 100-7.90= 92.10

Question 2

Assume it is now 25 November. You will get the loan to pay your creditor in February
(exactly 90 days from 25 November). The following quotations are available on 25
November.

3-month KLIBOR = 7.00%

February KLIBOR futures = 92.00

What will be the correct strategy to lock-in your borrowing cost? Prove that your strategy is
appropriate.

Short KLIBOR futures; locked in the interest at 8% in future. (100-92)

If the rate increase by 2%;

Profit from futures= (92.00-91.00) X 25 X 100=RM2,500

Borrowing cost= 1,000,000 X 0.09 X 90/360= RM22,500

Actual borrowing cost= RM22,500-RM2,500= RM20,000

20,000/1,000,000 = 2% for 3 months; 2% X 4= 8% (Annualized)

 BBMF2073 FOREX AND DERIVATIVES

Question 3

Assume that you are the Credit Officer and you have agreed to provide a customer with a
fixed rate, RM 10 million loan 180 days from today. You had priced the loan at 12% annual
interest rate.

The following quotes are available in the market.

3-month KLIBOR = 9%

6-month KLIBOR=10%

3-month KLIBOR futures = 90.0 (matures in 90 days)

6-month KLIBOR futures= 91.50 (matures in 180 days)

Discuss the appropriate strategy to protect yourself from a rise in interest rate and compute
the payoff.

Short the 6-month KLIBOR futures; locked in profit at 12%-8.50%= 3.50%

If interest rate increase by 2%;

Profit from futures= (91.50-88.00) X 50 X 100 X 10= RM175,000

Interest spread= (0.12-0.12)= 0

RM175,000/RM10,000,000= 1.75% for 6 months; 1.75% X 2= 3.50% (Annualized)

Question 4

You seek for the advice from your friend who works as a market analyst about the interest
rate expectation. He explains that the current economic conditions might lead to an
increase in interest rates over the next months. Given that the following information:

Current month: November

3-month KLIBOR= 7% (maturing on December)

December KLIBOR futures= 90.00

Justify how you can use KLIBOR futures to gain profit from your expectation.

Short December KLIBOR futures; Locked in KLIBOR at 10%

If interest rate increases by 2%; interest futures will suffer a 1% loss.

If interest rate increases by 3%; interest futures will have no gain and no loss.
 BBMF2073 FOREX AND DERIVATIVES

If interest rate increases by 4%; interest futures will have the profit.

Profit from futures if increase by 4%= (90.00-89.00) X 25 X 100 = RM2,500

Conclusion, if interest rate increases less than 3%, long the future. If interest rate increases
more than 3%, short the futures.

Question 5

Today is 23 November and you observe the following spot rates and futures price.

3-month KLIBOR = 6.5% [90 days till 24 September]

6-month KLIBOR = 8% [180 days till 23 December]
3-month KLIBOR futures = 93.00 [maturing 23 September]

Justify the appropriate arbitrage strategy and compute the payoff if arbitrage is possible.

[1 LongRate ( LongTenor / 360)]

[1 IFR (Tenor / 360)]
[1 ShortRate ( ShortTenor / 360)]
1 0.08 (180 / 360)
1 IFR (90 / 360)
1 0.065 (90 / 360)
1 IFR (90 / 360) 1.023370
IFR (1.023370 1) 360 / 90
0.0935 @ 9.35%

100-9.35= 90.65

Quoted 3-month KLIBOR futures= 93 > 90.65 (Overpriced)

Strategy: Short KLIBOR futures, long 6-month KLIBOR Spot

If interest increases by 2%; 3-month KLIBOR= 8.5%

Payoff for futures= (93.00 91.50) X 25 X 100= RM3,750

Payoff for long 6-m spot= (0.08-0.085) X 1,000,000 X 90/360 = (RM1,250)

Net profit= RM3,750 RM1,250 = RM2,500

If interest decreases by 2%; 3-month KLIBOR= 4.5%

Payoff for futures= (93.00-95.50) X 25 X 100 = (RM6,250)

Payoff for long 6-m spot= (0.08 0.045) X 1,000,000 X 90/360 = RM8,750

Net profit= RM8,750 RM6,250 = RM2,500

 BBMF2073 FOREX AND DERIVATIVES

Question 6

You work in the portfolio management department of a large insurance company. You are
worried about impeding interest rate increases on a bond portfolio you are managing. The
current value of the portfolio is RM2,875,200 and you wish to protect the portfolio from
diminution due to interest rate increases. You will be holding the portfolio for another 6
months at which point you will be required to fully liquidate it. Suppose that 5-year MGS
coupon is 6%, and yield is 7%.

MGS price= C Y 2 N Y 2 N
1 1 1 RM 100
Y 2 2
0.06 0.07
10
0.07
10

1 1 1 RM 100
0.07 2 2
(0.8571)[1 0.7089] (0.7089) RM 100
(0.9584) RM 100
RM 95.84

No of contracts= 2,875,200/ (95.84 X 1,000) = 30 contracts

At maturity, MGS yield increases by 1 %

MGS = C Y 2 N Y 2 N
1 1 1 RM 100
Y 2 2
0.06 0.08
9
0.08
9

1 1 1 RM 100
0.08 2 2
(0.75)[1 0.7026] (0.7026) RM 100
(0.9257) RM 100
RM 92.57

Value today Maturity P/L

Portfolio (2,875,200) 2,777,100 (98,100)
Short 30 MGS 2,875,200 (2,777,100) 98,100
Net = 0