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Introduction to Forwards and Futures

Using forwards and furutres in the Asset Liability management

Financial Institutions Management


Lecture 8, 9 Forwards, Futures and the Asset
Liability Management

Ai Jun Hou

Stockholm Business School, Stockholm University

         

                                         

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Introduction to Forwards and Futures
Using forwards and furutres in the Asset Liability management

Outline

1 Introduction to Forwards and Futures

2 Using forwards and furutres in the Asset Liability management

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Introduction to Forwards and Futures What are derivatives?
Using forwards and furutres in the Asset Liability management Introduction to the Forwards and futures

What is a “derivative”?

Definition (Derivative)
A derivative is a financial asset whose payoff depends on the value(s)
of one or several more basic underlying variables.

• Main types of derivatives: forward, futures, swaps, options


• Underlying variables: stock price, index, interest rates, credit risk,
commodity price, energy price, weather, number of catastrophic
events, . . .

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Introduction to Forwards and Futures What are derivatives?
Using forwards and furutres in the Asset Liability management Introduction to the Forwards and futures

Why are derivatives interesting?

• Very actively traded


• Useful for
I hedging risks

I “speculation”, i.e. gamble on the future direction of the market,

I locking in a risk-free profit

I change the nature of liabilities

I asset allocation

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Notation

T : delivery date
K : delivery price, paid at time T
St : price of underlying asset at time t
ftT : value/price at time t of long position in forward contract with
delivery date T and a given delivery price K
FtT : forward price at time t for delivery at time T , i.e. the value of K
that makes ftT = 0
r : risk-free interest rate over the relevant period, continuously
compounded
I does not have to be the same for all periods and at all points in
time, but that is not clear using Hull’s notation

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Introduction to Forwards and Futures What are derivatives?
Using forwards and furutres in the Asset Liability management Introduction to the Forwards and futures

Forwards
Definition (Forward)
A forward is an agreement to buy (or sell) an asset S at maturity T for
a fixed price K .

• A long position: Buy the asset, payoff at T is ST − K


• A short position: Sell the asset, payoff at T is K − ST
• Normally K is set so that it costs nothing to enter into a forward
contract ⇒
Payoff = Total gain (or loss) from the contract
This value of K is called the forward price.
• Forwards are traded/agreed upon in the OTC-markets
• Fairly organized OTC-market for currency forwards and interest
rate forwards

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Introduction to Forwards and Futures What are derivatives?
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Forward price on a non-dividend paying asset


Consider a long position in a forward contract on an asset with price
denoted by S.

With delivery at time T at a delivery price of K :

Payoff = ST − K

Present value (at time t < T ) of payoff is

PVt = St − Ke−r (T −t)

Solving PVt = 0 for K gives K = St er (T −t) so the forward price is

FtT = St er (T −t) .

For continuously compounding, or

FtT = St (1 + r )T −t .

For annually compounding, and Obviously FTT = ST .


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Introduction to Forwards and Futures What are derivatives?
Using forwards and furutres in the Asset Liability management Introduction to the Forwards and futures

Payoff function for forwards: long and Short position

Profit

K ST

 
 
 
 
 
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Introduction to Forwards and Futures What are derivatives?
Using forwards and furutres in the Asset Liability management Introduction to the Forwards and futures

Futures
• Like a forward
I a future is an agreement to buy (or sell) an asset at maturity for a

fixed price, but . . .


• Unlike a forward
I can be traded on an organized exchange

I the exchange specifies certain standardized features of the

contract
I gains and losses are settled each trading day (daily settlements)

I deposit an initial margin to the margin account


I when the value of futures inrease, long position holders are credit,

the short position holders are debited, vice versa


∗ FtT : futures price at time t with maturity T
∗ settlement payment at time t for a long position: FtT − Ft−1
T

∗ T T )
settlement payment at time t for a short position: −(Ft − Ft−1
∗ the futures value immediately after settlement payment is zero

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Introduction to Forwards and Futures What are derivatives?
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Margins
• A margin is cash or marketable securities deposited by an
investor with his or her broker
• The balance in the margin account is adjusted to reflect the
marking-to-market (=the daily settlement)
• Margins reduce the risk of default on a contract
• Initial margin: deposit when the contract is entered into
• Maintenance margin: Minimum balance on the margin account
• If the balance of the margin account falls below the maintenance
the investor gets a “margin call” and has to bring the balance
back to the initial margin
• The level of the initial and the maintenance margin may depend
on the type of trade
• Often some interest rate on the margin account

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Introduction to Forwards and Futures What are derivatives?
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Marking-to-market of gold futures of NYMEX example:


buy 200 ounces, the contract size is 100 ounces

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Introduction to Forwards and Futures What are derivatives?
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T-bills futures
• Call for delivery of a cash T-bill with $1 million in face values of
IMM index with 90 to 92-days maturity on CME
• Delivery occurs in March, June, September, December
• Treasury Bills and money market instruments are often quoted
using a discount rate: the interest earned as a percent of the final
value (principal) rather than of the initial price paid for the
instrument.
• The discount rate (d) is caculated as,,
F −p 360
)x( ) (
F t
where F is the face value, p is the quoted index price (points).
One basis point is 0.01%
• T-bill future calculations assume a 90 days maturity and a 360
days per year
• the Bond Equivalent Yield (BEY) is,
F −p 365
( )x( )
P t 15 / 50
Introduction to Forwards and Futures What are derivatives?
Using forwards and furutres in the Asset Liability management Introduction to the Forwards and futures

T-bills futures, Cont.


• T-bill futures are priced on a discount basis, quoted on an index
basis
I Calculated as 100 minus the annual percentage discount
I Example: the IMM Index is 95.19 implies a 4.81 %
(100-95.19=4.81) annualized discount
I A rising discount rate correspods to a falling index.
t
FT −bill = 1, 000, 000[1 − d( )]
360
where FT −bill = T − bill future prices, d is the annualized discount
rate, and d is calculated as (100-95.19)/100*360/t

if d = 6%, t = 90
90
FT −bill = 1, 000, 000[1 − 0.06( )] = 985, 000
360

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Introduction to Forwards and Futures What are derivatives?
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T-bills futures, Cont.

• One basis point (0.01%) move in future quote corresponds to a


gain or loss of 25 per contract

1, 000, 000x0.0001x90/360 = 25

• if d increase 0.01%, d = 6.01%,

90
FT −bill = 1, 000, 000[1 − 0.061( 360 )] = 984, 975, a loss in 25

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Introduction to Forwards and Futures What are derivatives?
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Treasury bond futures

• Call for delivery bonds that has a maturity of more than 15 years
(not callable) traded on the Chicago Board of Trade (CBOT)
• Contracts for four maturity dates per year: March, June,
September, December
• One contract involves the delivery of $100,000 of face value of
the bond.
• The quoted price for treasury bond is for a bond with a face value
of 100,
• Treasury bond futures are quoted in dollars and 32nd of a dollar,
I Example : a quote of 90-05 indicates that if the bond has a face
value of $100,000 its price will be (90+5/32)x1,000 = $90,156.25
(note that you might also see the quote expressed as: 151-20/32)

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Introduction to Forwards and Futures What are derivatives?
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Eurodollar Futures
• The 3-month Eurodollar futures contract is the most popular
interest rate futures contract in the US.
• A Eurodollar is a dollar deposited in a bank outside the United
States (can be a US or foreign bank).
• A 3-month Eurodollar futures contract is a futures contract on the
interest that will be paid (by someone who borrows at the
Eurodollar interest, same as 3-month LIBOR rate) on $1 million
for a future period of 3 months.
• Maturities are in March, June, September, and December, for up
to 10 years in the future.
• One contract is on the rate earned on $1 million
• A change of one basis point or 0.01% in a Eurodollar futures
quote corresponds to a contract price change of $25

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Introduction to Forwards and Futures What are derivatives?
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Eurodollar Futures, Continued

• A Eurodollar futures contract is settled in cash


• When it expires (on the third Wednesday of the delivery month)
the final settlement price is: 100 -R where R is the actual
3.month Eurodollar interest rate on that day.
• R uses an actual/360 day count convention.
• R is expressed with quarterly compounding.

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Introduction to Forwards and Futures What are derivatives?
Using forwards and furutres in the Asset Liability management Introduction to the Forwards and futures

Eurodollar Futures, Cont.

• When a Eurodollar futures quote increases by one basis point, a


trader who is long one contract gains $25 and a trader who is
short one contract loses $25.
• When a Eurodollar futures quote decreases by one basis point, a
trader who is long one contract loses $25 and a trader who is
short one contract gains $25.
• For example, if the settlement price changes from 99.120 to
99.230, a trader with a long position gains 11x25 = $275 per
contract. (99.23-99.12)%=0,0011=11 basis points)
• A trader with a short position loses $275 per contract.

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Introduction to Forwards and Futures The basis risk and optimal hedging ratio
Using forwards and furutres in the Asset Liability management Microhedge
Macrohedge: Duration based hedge

Asset and Liability Futures hedges

Buy Futures Sell Futures


Lengthen Asset X
Shorten Asset X
Lengthen Liability X
Shorten Liability X

Source: Hempel and Simonson’s Table 13.3 (p. 544)

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Introduction to Forwards and Futures The basis risk and optimal hedging ratio
Using forwards and furutres in the Asset Liability management Microhedge
Macrohedge: Duration based hedge

Rules for hedgeing with intesest rate futures

The basic rule for using short-term interest rates futures to hedge
interest rate risk:
• Using the long position to lock future investment yields (Long
Hedge).
I Avoiding lower than expected yields from loans, buy futures and
then cancel with a subsequent sale of similiar contracts
• Using the short position to lock future borrowing costs (Short
Hedge)
I Avoiding higher borrowing cost (against interest rate increases),
sell futures and then cancel with a subsequent purchase of similiar
contracts

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The microhedging with forwrds and futures
Introduction to Forwards and Futures The basis risk and optimal hedging ratio
Using forwards and furutres in the Asset Liability management Microhedge
Macrohedge: Duration based hedge

Asset and Liability hedges with Futures/Forwards


“Perfect hedge”: eliminates all uncertainty about future value

• Asset hedge (long hedge): To extend the maturity of an asset or


shorten the maturity of a liability , buy futures (against interest
rate falls)
• liability hedge(short hedge): To extend the maturity of a liability
or shorten the maturity of an asset, sell futures (against interest
rate rises)

number of forwards or futures used


Hedge ratio = number of units of the underlying asset

Note: For a perfect hedge using forwards, the hedge ratio is 1.


Similarly with futures?

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The microhedging with forwrds and futures
Introduction to Forwards and Futures The basis risk and optimal hedging ratio
Using forwards and furutres in the Asset Liability management Microhedge
Macrohedge: Duration based hedge

Basis
Not always possible to find a forward/futures contract that gives a
perfect hedge due to the basis risk

Basis: the difference between spot price and futures price:

Basis risk: uncertainty about the basis when the hedge is closed out
• Mismatch in dates, types, and positions, etc.
I Example: you need to hedge a position in eight month CDs, but the
future contracts are only aviable in six or nine month maturity
• Need to calculate the hedging ratio
In relations to the balance sheet, the basis risk refers to the
dfifferences in the price sensitivity to interest rates in the two markets
• certain depositors are unresponsive to the spread between
interest rates on deposits and open market interest rates

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The microhedging with forwrds and futures
Introduction to Forwards and Futures The basis risk and optimal hedging ratio
Using forwards and furutres in the Asset Liability management Microhedge
Macrohedge: Duration based hedge

Basis risk in hedging interest rate risk: microhedge


1 If one bank concerns interest rates increase, so to increase the
cost for funding liability at time = t, and sells the future contracts
at time = 0. Returns from a combined spot and future market
positions at time t:
R = (St − S0 ) + (F0 − Ft )
= (St − Ft ) − (S0 − F0 )
= Bt − B0
2 If one bank concerns interest rates decrease, so to reduce the
return for loans at time = t, and buys the future contracts at
time = 0. Returns from a combined spot and future market
positions at time t:
R = (S0 − St ) + (Ft − F0 )
= (S0 − F0 ) − (St − Ft )
= B0 − Bt
In all cases, the different between spot and future market prices
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The microhedging with forwrds and futures
Introduction to Forwards and Futures The basis risk and optimal hedging ratio
Using forwards and furutres in the Asset Liability management Microhedge
Macrohedge: Duration based hedge

The optimal number of futures contracts

Microhedge:
• Protects specific positions against unfavorable movements in
interest rates
• Reduces risk of individual assets and liabilities

h∗ VA
N∗ =
VF
where h∗ is the hedging ratio, VA is the value of the position being
hedged, VF is the value of one future contract

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The microhedging with forwrds and futures
Introduction to Forwards and Futures The basis risk and optimal hedging ratio
Using forwards and furutres in the Asset Liability management Microhedge
Macrohedge: Duration based hedge

The optimal number of futures contracts, Cont.

Macrohedge: Duration based hedge


• protect the equity values of the entire balance sheet /the entire
portfolios of the assets and liabilities, the number of future
contracts can be calcualted as:

ρ∆E
N∗ =
∆F
• where ρ is the cash and future correlations, ∆E is the equity
values, ∆F is gain and loss per futures contract, N is the number
of future contracts:
I a negative N indicates a short position and
I a positive N is a long positions
I a perfect hedge implies ρ = 1

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The microhedging with forwrds and futures
Introduction to Forwards and Futures The basis risk and optimal hedging ratio
Using forwards and furutres in the Asset Liability management Microhedge
Macrohedge: Duration based hedge

Example: extending the effective maturity of liability


First Place Financial Corporation (FPFC) is highly sensitive to many
banking matters but most of all to interest rate. On January 20, 1998,
the word is out in the market that short term interest rates will rise,
and First Place is worried about rolling over $10 million six month
CDs about ten weeks ahead on April 1. The present CD rate is 6.2
percent, and First Place would like to lock in this rate.
• At this soon to be bargain rate and the new rates, the CD interest
rate expense for six months (183 days) would be,

183
10, 000, 000[(0.062)( )] = 315, 167
360
183
10, 000, 000[(0.0825)( )] = 419, 375
360
• How does the First Place would like to lock in the Certificate
Deposit interest rate expense at 6.2 ? BlackBoard Demonstration

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Using forwards and furutres in the Asset Liability management Microhedge
Macrohedge: Duration based hedge

Table 13.4 First place financial corporation’s six month CD roll over

Date Cash Transactions Futures Transaction


Jan. 20, 1998 Bank anticipates rollover of Bank sells 20 three-month Eu-
$10,000,000 six-month CDs on rodollar futures at IMM in-
April 1. Expects rise in CD rate. dex=94.00 (Implied rate=6%)
Current CD rate=6.20%
$315,167

Apr.1, 1998 Bank completes rollover of Bank buys 20 three-month Eu-


$10,000,000 six-month CDs.CD rodollar futures at IMM in-
market rate=8.25% dex=92.00 (Implied rate=8%)
$419,375

Chang in CD interest cost: Gain on settlement variation:


$10, 000, 000[(0.0825 − 0.0620) 183 ] 200 bps × 20 contracts × $25
360
per bp=$100,000
$104,208

Cash(loss) $104, 208


Futures(gain) $100, 000
Net Loss $4,208

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The microhedging with forwrds and futures
Introduction to Forwards and Futures The basis risk and optimal hedging ratio
Using forwards and furutres in the Asset Liability management Microhedge
Macrohedge: Duration based hedge

Strip hedge to price fixed rate loans

Still, lending institutions favor floating rate over fixed rate loans
• Floaters help to match up the repricing of asstes and liabilities
• Customers tend to favor fixed rate loans to avoid uncertainties
about the future interest rate expense
• Use the forward rate to hedge the fluctuations in future interest
rate in a floating rate loan
• Implies the links between short term financial market to the fixed
rate long term loan

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The microhedging with forwrds and futures
Introduction to Forwards and Futures The basis risk and optimal hedging ratio
Using forwards and furutres in the Asset Liability management Microhedge
Macrohedge: Duration based hedge

Links between short term financial market to the fixed


rate L-T loan
Lending institutions favor floating rate over fixed rate loans
MicroCheap Electronic, a national discount electronic products
retailer asks ABC ROAM bank’s Chicago office to provide a one year
$100 million fixed rate loan on December 17 to begin immediately.
ABC ROAM responds with a fixed rate offer of 9% but as an
inducement to sell a floating deal, suggests to MicroCheap that it
might realize some saving at a loan rate that floats at 175 basis points
(1.75 %) over adjusted quarterly three-month LIBOR rate.
• The current LIBOR rate is 6.25 %
• The present implied yields on Eurodollar CD futures for the
period covered by the loan are: 6.5%, 6.75%, and 7%
respectively, for the March, June, and September contracts
• if MicroCheap take ABC’s suggestion, the estimated annual
interest rate cost is 8.583%
• (calculation on blackboard)
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The microhedging with forwrds and futures
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Using forwards and furutres in the Asset Liability management Microhedge
Macrohedge: Duration based hedge

Bond equivalent interest for current spot and Eurodollar futures

ED Futures Delivery Discount Bond Equiv. Yi- BEY 1% rise in


Month eld BEY Discount
December 6.25% 6.437%
March 6.50% 6.702% 7.750%
June 6.75% 6.964% 8.040%
September 7.00% 7.225% 8.280%

BEY is Calculated as

90
Price = $1, 000, 000[1 − 0.0625( )] = $984, 375
360
Discount = $1, 000, 000 − 984, 375 = $15, 625
15, 625 365
BEY = × = 6.437%
984, 375 90

Day counts for quarters following December 17, March 1June 17 and September 16 are 90,92,92
and 91.

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Using forwards and furutres in the Asset Liability management Microhedge
Macrohedge: Duration based hedge

The annual cost for a floating rate loan

Annual Cost rate = (1 + y )


90
= [1 + (0.06437 + 0.0175)( )]
365
92
X [1 + (0.06702 + 0.0175)( )]
365
92
X [1 + (0.06964 + 0.0175)( )]
365
91
X [1 + (0.07225 + 0.0175)( )]
365
= 1.0853
y = 8.583%

This rate implies an important link between the short term financial
market to the pricing of the fixed rate longer term loans.
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Using forwards and furutres in the Asset Liability management Microhedge
Macrohedge: Duration based hedge

Pelling a Eurodollar Strip

ˆ
Dec ˆ
March ˆ
June ˆ
Sep

Sell 100-Mar Del 100-Mar

Sell 100-Jun Del 100-Jun

Sell 100-Sep Del 100-Sep

Borrow:

0.0819 0.0845% 0.0871% 0.0898%

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Introduction to Forwards and Futures The basis risk and optimal hedging ratio
Using forwards and furutres in the Asset Liability management Microhedge
Macrohedge: Duration based hedge

Borrow and hedge Cash Flows from the strip hedge


Date Cash Futures
Dec 17 Take down $100M lo- Sell 100 Mar ED contr. 93.5 Sell
an: 3-month financing 100 Jun ED contr. 93.25 Sell 100
(0.06437+0.0175)=0.08187 Sep ED contr. 93.00
discount rates rise 1% on Dec Settlement variation =$750,000
17 after financing (100bps × $25/bp × 300 con-
tracts)
Mar 18 3-month ED Discount=7.5% Pay $2,018,712 Del 100 Mar ED contr. 92.50
Dec-Mar financing (0.08187 ×
90/365 × $100M)
Jun 17 3-month ED Discount=7.75% $2,395,217 Del 100 Jun ED contr. 92.25
Pay Mar-Jun financing
((0.0775+0.0175) × 92/365
× $100M)
Sep 16 3-month ED Discount=8.00% $2,467,616 Del 100 Sep ED contr. 92.00
Pay Jun-Sep financing
((0.0804+0.0175) × 92/365
× $100M)
Dec 17 Pay Sep-Dec financing $2,500,630
((0.0828+0.0175) × 91/365
× $100M)

(Blackboard calculation)
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The microhedging with forwrds and futures
Introduction to Forwards and Futures The basis risk and optimal hedging ratio
Using forwards and furutres in the Asset Liability management Microhedge
Macrohedge: Duration based hedge

The effective borrowing rate is the YTM of the cash


flows
• The effective borrowing rate with hedging willbe:
−750, 000 + 2, 018, 712 2, 395, 217
100, 000, 000 = +
(1 + y)0.25 (1 + y )0.5
2, 467, 616 2, 500, 630 100, 000, 000
+ + +
(1 + y )0.75 (1 + y ) (1 + y )
y = 8.86%
• This is much lower than the rate without hedging
2, 018, 712 2, 395, 217
100, 000, 000 = +
(1 + y)0.25 (1 + y )0.5
2, 467, 616 2, 500, 630 100, 000, 000
+ + +
(1 + y )0.75 (1 + y ) (1 + y )
y = 9.7%
• The effectic borrowing rate would be higher if the rise in EUrodollar
discount occured at a later date, e.g.,March 18.
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Macrohedge: Duration based hedge

Table 4.5 Interest rate exposure to Snow Bank’s Balance Sheet

Present value Years Duration After 2% int. increase


Assets
Securities
Liquid 150 0.5 148.6
InvestM 100 3.5 93.6
loans
Floating 400 0 400
Fix-rate 350 2 337.3
Total Assets 1000 1.125 979.5
Liab. & net worth
Trans.Depos. 400 0 400
CDs & TD
Short-term 350 0.4 347.5
Long-term 150 2.5 143.7
Net worth 100 88.3

Total Liabi. & net worth 1000 0.572 979.5


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Using forwards and furutres in the Asset Liability management Microhedge
Macrohedge: Duration based hedge

Hedge against the loss in equity


Recall the previous lecture,
L
DG = DA − DL = 0.610
A
4r 0.02
4E = −DG[ ]A = −0.610x x1000m = −11.1m
(1 + r ) 1 + 0.1

• One percent increase in interest rates, the equity will decrease ∆E = −5.55m
• Firms with a positive duration gap (positive equity duration), Rising interest rate
produces a loss—liability sensitive (be aware of the typo on Hempel &Simonsson
(1999), P551, second paragraph, second line, the asset should be liabiity, the last
word “asset” of the thrid line should be asset)
• Firms with negative duration gap (negative equity duration), falling in interest rate
produces a loss—asset sensitive
• Future contracts can be used to macrohedge the loss when interest rate
rises/falls
• The most liquid and liquid futures are those for 20 years treasury bonds and 91
days Eurodollar CDs
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The microhedging with forwrds and futures
Introduction to Forwards and Futures The basis risk and optimal hedging ratio
Using forwards and furutres in the Asset Liability management Microhedge
Macrohedge: Duration based hedge

Hedge against the loss in equity with Treasury bond

• If the future prices changes perfectly correlated with the changes


in equity values,
• The total number of future contarcts needed to hedge the loss in
equity is,

∆E 5, 550, 000
N=− =− = −2220
∆F 2500
Why 2500 here?
One bps change in bond quote corresponds to a gain or loss of
25 per contract, 100 bps is 2500

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The microhedging with forwrds and futures
Introduction to Forwards and Futures The basis risk and optimal hedging ratio
Using forwards and furutres in the Asset Liability management Microhedge
Macrohedge: Duration based hedge

Hedge against the loss in equity with Treasury bond


futures
• Recall that a future price of 111-09 means that the future prices
is: 111,281.25 =111+9/32
• if the conversion factor of a 9 % coupon of 20 years is 1.063,
then the selling price is: 118, 291.97 = 1.063x111, 281.25
• From previous equation, we get,

4r
4F = −DF [ ]Fp
(1 + r )
where Fp = futures contract price, and Df = duration of futures
contract
• Substituting ∆E and ∆F into N = − ∆E∆F , we get,

−DG(A) 0.610(1, 000m)


N= =− = −731.86
DF (FP ) 7.49(111, 281.25)
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The microhedging with forwrds and futures
Introduction to Forwards and Futures The basis risk and optimal hedging ratio
Using forwards and furutres in the Asset Liability management Microhedge
Macrohedge: Duration based hedge

Hedge against the loss in equity with Eurodollar


futures, Cont.
• If the interest rate rises up 1%

∆F (N) = ∆E
∆r
= −DF ( )(FP )(N)
1+r
+0.01
= −7.49[ ](111, 281.25)(−732)
1.1
= 5, 546, 541

• Problems with the macrohedge


I The assumption of the liner relation between the duration and the

interest rates, although the price-interest rate changes are convex


I prices rises more for a given decrease than they fall for the same

interest
I basis risk

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The microhedging with forwrds and futures
Introduction to Forwards and Futures The basis risk and optimal hedging ratio
Using forwards and furutres in the Asset Liability management Microhedge
Macrohedge: Duration based hedge

Hedge against the loss in equity with Eurodollar


futures, Cont.

• Basis risk is minimized by choosing futures contract that are


highly correlated with the cash position
• Assume that ρ = 0.80, implying that the equity value of the
balance sheet will move 80% of the movement in the price of the
selected T-bonds futures
• ρ can be estimated as the coefficient of regressing the ∆E onto
∆F ,

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The microhedging with forwrds and futures
Introduction to Forwards and Futures The basis risk and optimal hedging ratio
Using forwards and furutres in the Asset Liability management Microhedge
Macrohedge: Duration based hedge

Hedge against the loss in equity with Eurodollar


futures, Cont.
• The number of futures can be calculated as,

∆E(ρ) = N ρ ∆F
∆E(ρ)
Nρ =
∆F
where ρ = the future and equity correlations, N ρ is the number of
futures modified by ρ
• In the previous example,

∆E(ρ)
Nρ = ∆r
−DF [ 1+r ]FP
5, 550, 000(0.8)
= 0.01
−7.49[ 1+0.1 ]111, 281.25
= −585.5
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The microhedging with forwrds and futures
Introduction to Forwards and Futures The basis risk and optimal hedging ratio
Using forwards and furutres in the Asset Liability management Microhedge
Macrohedge: Duration based hedge

Reading materials

1 Lecture Note Part 1


I Chapter 1, 2; Chapter 6; Chapter 7.1, Chapter John Hull (2012),
”Options, furtures and other derivatives”, Eighth edition, Pearson
2 Chapter 13, Hempel, G.H. & Simonson, D.G. (1999), ”Bank
Management: Text and Cases”, Fifth Edition, John Wiley & sons,
Inc.
3 Chapter 8, Rose & Hudgins (2012),”Bank management &
Financial Services”, Nineth edition, McGraw Hill

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