CHAPTER 7INTEREST RATE FUTURES.ppt

Chapter 7 CHAPTER 7INTEREST RATE FUTURES In this chapter, we explore one of the most successful innovations in the history of futures markets; that is, interest rate futures contracts. This chapter is organized into the following sections: Interest Rate Futures Contracts Pricing Interest Rate Futures Contracts Speculating With Interest Rate Futures Contracts Hedging With Interest Rate Futures Contracts Interest Rate Futures Introduction Interest rate futures contracts are one of the most successful innovations in futures trading. Pioneered in the United States, they have expanded internationally with strong presence in Great Britain and Singapore. The CBOT specializes in contracts with long-term maturity (e.g., 2-year, 5-year and 10-year T-notes, and 5-year LIBOR-based swaps). The CME International Monetary Market (IMM) specializes in contracts with short-term maturity (e.g., 1-month, and 3-month Eurodollar deposits). Short-Term Interest Rates Contracts In this section, four short-term interest rate futures contracts will be examined: Eurodollar Futures Euribor Futures TIEE 28 Futures Treasury Bill Futures Eurodollar Futures Product Profile Eurodollar Futures Eurodollar futures currently dominate the U.S. market for short-term futures contracts. Rates on Eurodollar deposits are usually based on LIBOR (London Interbank Offer Rate). LIBOR is the rate at which banks are willing to lend funds to other banks in the interbank market. Eurodollars are U.S. dollar denominated deposits held in a commercial bank outside the U.S. The Eurodollar contracts is for $1,000,000. A Eurodollar futures contract is based on a time deposit held in a commercial bank (e.g., 3-month Eurodollar) Eurodollar contracts are non-transferable. Eurodollar Futures Eurodollar futures were the first contract to use cash settlement rather than delivery of an actual good for contract fulfillment. To establish the settlement rate at the close of trading, the IMM determines the thr