Futures Hedging Examples

1
Futures Hedging Examples
2
Hedging Examples

• T-Bills to Buy with T-Bill Futures
• Debt Payment to Make with Eurodollar Futures
• Futures in Portfolio Hedging

3
T-Bills, Notes Bonds

• Treasury Securities
• lt 1 yr. Maturity T-Bills, Discount Basis
• gt1 yr., lt 10 yr. Maturity T-Notes, Coupon
  Bond
• gt10 yr. Maturity T-Bonds, Coupon Bond

4
T-Bills

• Pricing (Discount Basis)
• (1 - discount(91/360))1million
• Mar 19 w/ 27 days to Maturity priced at a
  discount of 4.68. Price on 1 million
  Face (1-.0468(27/360))1 million 996,490

5
T-Bill Futures

• Delivery of 91-day T-Bill at maturity date. So,
  a March futures delivers a June T-Bill.
• Pricing on a discount basis, but quoted .
• Feb. 19, March 95.02 gt discount 4.98
• 100 - (4.9891/360)
• ----------------------- 1 million 987,412
• 100

6
Hedging a 25MM T-Bill Purchase

• Previous T-Bill futures has us buy 25mill /
  987,412 25.3187 contracts
• If rates at delivery are 5.5, T-Bills
  cost (1-(.05591/360))1mill 986,097
• Futures lost (986,097 - 987,412)25.3187
  (33294), leaving 24,966,706 for T-Bills, but
  this still buys us 24,966,706 /
  986,097 25.3187 1mill. T-Bills

7
Hedging a T-Bill Purchase

• If rates at delivery are 4.5, T-Bills
  cost (1-(.04591/360))1mill 988,625
• Futures gained (988,625 - 987,412)25.3187
  30,712, leaving 25,030,712 for T-Bills,
  but this just buys us 25,030,712/
  988,625 25.3187 1mill. T-Bills
• So, whether rates go up or down, buying March
  T-Bill futures locks in delivery.

8
Eurodollar Futures

• Among the most liquid and actively traded futures
  contracts in the world
• Eurodollar a dollar deposit in a U.S. or
  foreign bank outside the U.S.
• The contract
• Underlying 90-day hypothetical Eurodollar CD
• Contract Size 1 mm face value
• One basis point (.01) is worth 25
• Contract Months March, June, Sep, Dec, serial
  months, spot month
• Maturities Available through 10 years

9
Hedge Floating Rate Payment

• Assume an unknown Floating Rate to be paid in
  3-months on 100,000,000.
• Short 100 (1,000,000) Euro Futures today at
  94.555 (or Yield of 5.445).
• Settle in 3-months at 94.35 or 94.75. Use
  proceeds from futures to make debt payment.

10
Hedge Floating Rate Payment

• Futures settles at spot of 94.35 (5.65).
  Floating Payment is .0565.25100M 1,412,500
• Futures settles for 94.555-94.35 .205 (where
  each .01 25), for a gain of 20.525100
  contracts 51,250
• Net Debt Payment 1,412,500 - 51,250
  1,361,250

11
Hedge Floating Rate Payment

• Futures settles at spot of 94.75 (5.25).
  Floating Payment is .0525.25100M 1,312,500
• Futures settles for 94.555-94.75 -.195 (where
  each .01 25), for a loss of
  -19.525100 contracts - 48,750
• Net Debt Payment 1,312,500 48,750
  1,361,250

12
Hedging Futures

• No up front transfer of funds, but daily
  marking-to-market.

13
Hedging Futures

• Number of Futures Contracts to Hedge is a
  function of Relation of Portfolio Returns with
  Index Returns (Portfolio Beta with Index).
• Assume a 7 mill. Portfolio that has a Beta of
  1.40 with some Index. The Index Futures is
  currently at 600 and it trades for 500 per Index
  point.

14
Hedging Futures