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1、Copyright 2010 Pearson Education,Inc.Publishing as Prentice Hall,27-1,Chapter 27Interest-Rate Futures Contracts,Copyright 2010 Pearson Education,Inc.Publishing as Prentice Hall,27-2,Learning Objectives,After reading this chapter,you will understandwhat a futures contract isthe differences between a
2、futures and a forward contractthe basic features of various interest-rate futures contractsthe cheapest-to-deliver issue for a Treasury bond futures contract and how it is determinedhow the theoretical price of a futures contract is determinedhow the theoretical price of a Treasury bond futures cont
3、ract is affected by the delivery optionshow futures contracts can be used in bond portfolio management:speculation,changing duration,yield enhancement,and hedginghow to calculate the hedge ratio and the number of contracts to short when hedging with Treasury bond futures contracts.,Copyright 2010 Pe
4、arson Education,Inc.Publishing as Prentice Hall,27-3,Mechanics of Futures Trading,A futures contract is a firm legal agreement between a buyer(seller)and an established exchange or its clearinghouse in which the buyer(seller)agrees to take(make)delivery of something at a specified price at the end o
5、f a designated period of time.The price at which the parties agree to transact in the future is called the futures price.The designated date at which the parties must transact is called the settlement date.The contract with the nearest settlement date is called the nearby futures contract.The next f
6、utures contract is the one that settles just after the nearby contract.The contract furthest away in time from settlement is called the most distant futures contract.,Copyright 2010 Pearson Education,Inc.Publishing as Prentice Hall,27-4,Mechanics of Futures Trading(continued),Opening PositionWhen an
7、 investor takes a position in the market by buying a futures contract,the investor is said to be in a long position or to be long futures.If,instead,the investors opening position is the sale of a futures contract,the investor is said to be in a short position or short futures.Liquidating a Position
8、A party to a futures contract has two choices on liquidation of the position.First,the position can be liquidated prior to the settlement date.The alternative is to wait until the settlement date.For some futures contracts,settlement is made in cash only.Such contracts are referred to as cash-settle
9、ment contracts.,Copyright 2010 Pearson Education,Inc.Publishing as Prentice Hall,27-5,Mechanics of Futures Trading(continued),Role of the ClearinghouseAssociated with every futures exchange is a clearinghouse.A futures contract is an agreement between a party and a clearinghouse associated with an e
10、xchange.The clearinghouse makes it simple for parties to a futures contract to unwind their positions prior to the settlement date.When an investor takes a position in the futures market,the clearinghouse takes the opposite position and agrees to satisfy the terms set forth in the contract.Because t
11、he clearinghouse exists,the investor need not worry about the financial strength and integrity of the party taking the opposite side of the contract.Besides its guarantee function,the clearinghouse makes it simple for parties to a futures contract to unwind their positions prior to the settlement da
12、te.,Copyright 2010 Pearson Education,Inc.Publishing as Prentice Hall,27-6,Mechanics of Futures Trading(continued),Margin RequirementsWhen a position is first taken in a futures contract,the investor must deposit a minimum dollar amount per contract as specified by the exchange.This amount,called the
13、 initial margin,is required as deposit for the contract.At the end of each trading day,the exchange determines the settlement price for the futures contract.This price is used to mark to market the investors position,so that any gain or loss from the position is reflected in the investors equity acc
14、ount.,Copyright 2010 Pearson Education,Inc.Publishing as Prentice Hall,27-7,Mechanics of Futures Trading(continued),Margin RequirementsThe maintenance margin is the minimum level(specified by the exchange)by which an investors equity position may fall as a result of an unfavorable price movement bef
15、ore the investor is required to deposit additional margin.The additional margin deposited,called the variation margin,is the amount necessary to bring the equity in the account back to its initial margin level.The concept of margin differs for securities and futures.When securities are acquired on m
16、argin,the difference between the price of the security and the initial margin is borrowed from the broker with the security purchased serving as collateral for the loan.For futures contracts,the initial margin,in effect,serves as“good faith”money,an indication that the investor will satisfy the obli
17、gation of the contract.,Copyright 2010 Pearson Education,Inc.Publishing as Prentice Hall,27-8,Mechanics of Futures Trading(continued),CommissionsCommissions on futures contracts are fully negotiable.They are usually quoted on the basis of a round turn,a price that includes the opening and closing ou
18、t of the futures contract.In most cases,the commission is the same regardless of the maturity date or type of the underlying instrument.Commissions for institutional accounts vary enormously,ranging from a low of about$11 to a high of about$30 per contract.,Copyright 2010 Pearson Education,Inc.Publi
19、shing as Prentice Hall,27-9,Futures Versus Forward Contracts,Just like a futures contract,a forward contract is an agreement for the future delivery of the underlying at a specified price at the end of a designated period of time.Futures contracts are traded on organized exchanges and are standardiz
20、ed agreements as to the delivery date(or month)and quality of the deliverable.A forward contract differs in that it has no clearinghouse,usually has nonstandardized contracts(i.e.,the terms of each contract are negotiated individually between buyer and seller),and typically has nonexistent or extrem
21、ely thin secondary markets.Because there is no clearinghouse that guarantees the performance of a counterparty in a forward contract,the parties to a forward contract are exposed to counterparty risk.,Copyright 2010 Pearson Education,Inc.Publishing as Prentice Hall,27-10,Risk and Return Characterist
22、ics of Futures Contracts,The buyer of a futures contract will realize a profit if the futures price increases;the seller of a futures contract will realize a profit if the futures price decreases.If the futures price decreases,the buyer of a futures contract realizes a loss while the seller of a fut
23、ures contract realizes a profit.When a position is taken in a futures contract,the party need not put up the entire amount of the investment.Instead,only initial margin must be put up.Although the degree of leverage available in the futures market varies from contract to contract,the leverage attain
24、able is considerably greater than in the cash market.Futures markets can be used to reduce price risk.Without the leverage possible in futures transactions,the cost of reducing price risk using futures would be too high for many market participants.,Copyright 2010 Pearson Education,Inc.Publishing as
25、 Prentice Hall,27-11,Currently Traded Interest-Rate Futures Contracts,Most major financial markets outside the United States have futures contracts similar to the U.S.Several of the more important interest-rate futures contracts in the United States are described in the following sections.For the fi
26、rst threeTreasury bills futures contract,Eurodollar futures contract,and federal funds futures contractthe underlying interest rate is a short-term(money market)interest rate.For the other contractsTreasury bond futures,Treasury notes futures,and municipal note index futuresthe underlying interest r
27、ate is a longer term interest rate.Most major financial markets outside the United States have similar futures contracts in which the underlying security is a fixed-income security issued by the central government.,Copyright 2010 Pearson Education,Inc.Publishing as Prentice Hall,27-12,Currently Trad
28、ed Interest-Rate Futures Contracts(continued),Eurodollar FuturesEurodollar futures contracts are traded on both the International Monetary Market of the Chicago Mercantile Exchange and the London International Financial Futures Exchange.The Eurodollar certificate of deposit(CD)is the underlying for
29、this contract.A Eurodollar CD is a dollar-denominated CD issued outside of the United States,typically by a European bank.Three-month LIBOR is the underlying for the Eurodollar futures contract.That is,the parties are agreeing to buy and sell“three-month LIBOR.”,Copyright 2010 Pearson Education,Inc.
30、Publishing as Prentice Hall,27-13,Currently Traded Interest-Rate Futures Contracts(continued),Eurodollar FuturesA Eurodollar futures contract is quoted on an index price basis.From the futures index price,the annualized futures three-month LIBOR is determined as follows:100 minus the index price.For
31、 example,a Eurodollar futures index price of 94.52 means the parties to this contract agree to buy or sell the three-month LIBOR for 5.48%.Since the underlying is an interest that obviously cannot be delivered,this contract is a cash settlement contract.,Copyright 2010 Pearson Education,Inc.Publishi
32、ng as Prentice Hall,27-14,Currently Traded Interest-Rate Futures Contracts(continued),Eurodollar FuturesThe face value for a Eurodollar Futures contract is$1 million.A on-tick change in the index price for this contract is 0.01;that is,an index price change of,for example,94.52 to 94.53 is 0.01 or o
33、ne tick.An index price change from 94.52 to 94.53 changes the three-month LIBOR from 5.48%to 5.47%.In terms of basis points,a one-tick change in the index price means a1-basis-point(0.0001)change in the three-month LIBOR.The simple interest on$1 million for 90 days is equal to$1,000,000(LIBOR 90/360
34、)If LIBOR changes by 1 basis point(0.0001),then$1,000,000(0.0001 90/360)=$25Hence,a one-tick change in the index price or,equivalently,a 1-basis-point change in the three-month LIBOR means a$25 change in the value of the contract.,Copyright 2010 Pearson Education,Inc.Publishing as Prentice Hall,27-1
35、5,Currently Traded Interest-Rate Futures Contracts(continued),Eurodollar FuturesThe minimum price fluctuation for the index price is a half a tick,or$12.50.In the nearest trading month for this contract,the minimum index price fluctuation is a quarter tick,or$6.25.The contracts are listed for March,
36、June,September,and December(referred to as the“March cycle”),40 months in the March quarterly cycle,and the four nearest serial contract months.To understand this,see Exhibit 27-1,which shows the contracts listed on the CME on January 2,2008.(See truncated version of Exhibit 27-1 in Overhead 27-16.)
37、Also shown in the Exhibit 27-1 is the first day of trade,the last day of trade,the cash settlement date,and the date the contract will be deleted.,Copyright 2010 Pearson Education,Inc.Publishing as Prentice Hall,27-16,Exhibit 27-1 Listed CME Eurodollar Futures Contracts on January 2,2008,Copyright 2
38、010 Pearson Education,Inc.Publishing as Prentice Hall,27-17,Currently Traded Interest-Rate Futures Contracts(continued),Eurodollar FuturesThe Eurodollar futures contract is a cash settlement contract.That is,the parties settle in cash based on three-month LIBOR at the settlement date.Suppose that a
39、trade occurs at 94.52 and on the settlement date the settlement index price is 95.00.From the perspective of the buyer,the index price increased.Hence,the seller must pay the buyer 0.48.Since one tick is$25 and 0.48 is 48 ticks,the buyer receives from the seller 48$25=$1,200.An alternative way of th
40、inking about this is that the buyer contracted to receive a three-month interest rate of(100.00%-94.52%)=5.48%.,Copyright 2010 Pearson Education,Inc.Publishing as Prentice Hall,27-18,Currently Traded Interest-Rate Futures Contracts(continued),Eurodollar FuturesAt the settlement date,the index price
41、is 95.00.This means a three-month LIBOR of 5.00%interest rate is available in the market.The compensation of$1,200 of the seller to the buyer is for the lower prevailing three-month LIBOR of 5.00%rather than the contracted amount of 5.48%.To see how this contract is used for hedging,suppose that a m
42、arket participant is concerned that its borrowing costs six months from now are going to be higher.To protect itself,it takes a short(selling)position in the Eurodollar futures contract such that a rise in short-term interest rates will benefit.,Copyright 2010 Pearson Education,Inc.Publishing as Pre
43、ntice Hall,27-19,Currently Traded Interest-Rate Futures Contracts(continued),Eurodollar FuturesTo see this,consider our previous illustration in the Eurodollar futures at 94.52(5.48%rate).Suppose at the settlement date the three-month LIBOR increases to 6.00%and,therefore,the settlement index price
44、is 94.00.This means that the seller sold the contract for 94.52 and purchased it for 94.00,realizing a gain of 0.52 or 52 ticks.The buyer must pay the seller 52$25=$1,300.The gain from the short futures position is then used to offset the higher borrowing cost resulting from a rise in short-term int
45、erest rates.,Copyright 2010 Pearson Education,Inc.Publishing as Prentice Hall,27-20,Currently Traded Interest-Rate Futures Contracts(continued),Euribor FuturesFor euro-denominated loans and derivatives,when a reference rate is used,it is typically the Euro Interbank Offered Rate(Euribor).Euribor is
46、the rate on deposits denominated in euros.The Euribor futures contract,traded on the NYSE Euronext,and the Eurodollar futures contract are the most actively traded futures contracts in the world.The Euribor futures contract is similar to the Eurodollar futures contract.The unit of trading is 1,000,0
47、00,and it is a cash-settled contract.The underlying is 30-day Euribor.,Copyright 2010 Pearson Education,Inc.Publishing as Prentice Hall,27-21,Currently Traded Interest-Rate Futures Contracts(continued),Federal Funds Futures ContractDepository institutions are required to maintain reserves at the Fed
48、eral Reserve.Banks that have excess reserves do not earn interest on those funds.However,they can lend those funds through the Federal Reserve to other banks that need reserves.The funds lent are called federal funds.The interest rate at which banks lend balances at the Federal Reserve to other bank
49、s on an overnight basis called the federal funds rate or simply fed funds rate.The 30-day federal funds futures contract,traded on the CBOT,is designed for financial institutions and businesses that want to control their exposure to movements in the federal funds rate.These contracts are marked to m
50、arket using the effective daily federal funds rate as reported by the Federal Reserve Bank of New York.,Copyright 2010 Pearson Education,Inc.Publishing as Prentice Hall,27-22,Currently Traded Interest-Rate Futures Contracts(continued),Treasury Bond FuturesThe Treasury bond futures contract is traded
