Learning objectives: Describe the impact of the level and shape of the yield curve on the cheapest-to-deliver Treasury bond decision. Calculate the theoretical futures price for a Treasury bond futures contract. Calculate the final contract price on a Eurodollar futures contract and compare Eurodollar futures to FRAs. Describe and compute the Eurodollar futures contract convexity adjustment. Calculate the duration-based hedge ratio and create a duration-based hedging strategy using interest rate futures. Explain the limitations of using a duration-based hedging strategy.
Questions:
23.6.1. In April 2023, CME Group will convert (or has converted!) open three-month Eurodollar (ED) futures contract position into three-month SOFR futures contracts, aka SOFR SR3 contracts where SOFR refers to the Secured Overnight Financing Rate. The new SOFR SR3 contracts are structured similarly to the old Eurodollar (ED) contracts. In regard these essential similarities (and few differences) between the SOFR S3 contract and the ED future contract, each of the following is true EXCEPT which is false?
a. In both cases (SR3 and ED), the settlement of the contracts occurs at the beginning the underlying three-month period
b. In both cases (SR3 and ED), the future quote price (including the settlement price) equals 100 minus the reference interest rate
c. In both cases (SR3 and ED), the contract is structured so that a one basis-point move in the quote leads to gain/loss of USD $25.00
d. The SR3 reference rate is the interest earned if compounded daily over the prior three months, while the ED reference rate is the three-month US dollar LIBOR expressed with quarterly compounding and an actual/360 (aka, ACT/360) day count convention.
23.6.2. Suppose a trader has USD $5.0 million position in a six-month money market instrument. Because it is a zero-coupon instrument, she (rounds up) and assumes its modified duration is six months. Which of the following is nearest to the number of three-month SOFR (or Eurodollar) contracts that will approximately hedge a small parallel shift in the interest rate term structure?
a. One contract
b. 10 contacts
c. 25 contracts
d. 300 contracts
23.6.3. It is March 20, 2023. The cheapest-to-deliver bond in the December 2023 Treasury bond futures contract is expected to be a bond with a duration of 12.80 at that time. The current futures price is 102-05 (or 102.156250). A bond portfolio has a duration of 8.50 and is worth USD 40 million. How many bond futures contracts are necessary to hedge the risk in the portfolio?
a. 27
b. 133
c. 260
d. 444
Answers here:
Questions:
23.6.1. In April 2023, CME Group will convert (or has converted!) open three-month Eurodollar (ED) futures contract position into three-month SOFR futures contracts, aka SOFR SR3 contracts where SOFR refers to the Secured Overnight Financing Rate. The new SOFR SR3 contracts are structured similarly to the old Eurodollar (ED) contracts. In regard these essential similarities (and few differences) between the SOFR S3 contract and the ED future contract, each of the following is true EXCEPT which is false?
a. In both cases (SR3 and ED), the settlement of the contracts occurs at the beginning the underlying three-month period
b. In both cases (SR3 and ED), the future quote price (including the settlement price) equals 100 minus the reference interest rate
c. In both cases (SR3 and ED), the contract is structured so that a one basis-point move in the quote leads to gain/loss of USD $25.00
d. The SR3 reference rate is the interest earned if compounded daily over the prior three months, while the ED reference rate is the three-month US dollar LIBOR expressed with quarterly compounding and an actual/360 (aka, ACT/360) day count convention.
23.6.2. Suppose a trader has USD $5.0 million position in a six-month money market instrument. Because it is a zero-coupon instrument, she (rounds up) and assumes its modified duration is six months. Which of the following is nearest to the number of three-month SOFR (or Eurodollar) contracts that will approximately hedge a small parallel shift in the interest rate term structure?
a. One contract
b. 10 contacts
c. 25 contracts
d. 300 contracts
23.6.3. It is March 20, 2023. The cheapest-to-deliver bond in the December 2023 Treasury bond futures contract is expected to be a bond with a duration of 12.80 at that time. The current futures price is 102-05 (or 102.156250). A bond portfolio has a duration of 8.50 and is worth USD 40 million. How many bond futures contracts are necessary to hedge the risk in the portfolio?
a. 27
b. 133
c. 260
d. 444
Answers here:
