FBE459_1_3_Interest_Rate_Futures

# FBE459_1_3_Interest_Rate_Futures - Lecture Outline FBE 459...

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1 FBE 459 – Financial Derivatives Prof. Pedro Matos Lecture 1.3: Interest Rate Futures Currency (FX) Futures • Currency (FX) Futures • Basics of Interest Rates • Interest Rate Forwards and Futures Readings: HULL chapters 4, 6 - Currency (FX) forwards & futures - Interest rates: the basics - Short-term interest rate forwards & futures . forward rate agreements Lecture Outline: 2 . Eurodollar futures - Long-term interest rate forwards & futures . T-Bond futures FX Forwards & Futures: • Forward on foreign currencies A foreign currency is analogous to a security providing a dividend yield = the foreign risk-free interest rate ( r f ) F S e rr T f () 3 S = r = r f = T= 00 FX Forwards & Futures: • No-arbitrage pricing of FX forward: S 0 = GBP/USD spot rate F 0,T = GBP/USD t=T forward rate r = interest rate in USD r = interest rate in GBP 4 f interest rate in GBP If you have today GBP 1,000 can invest it two ways: - deposit in GBP and sell (short) GBP forward - sell GBP now and deposit in USD

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2 FX Forwards & Futures: • No-arbitrage pricing of FX forward: How much can I get on GBP1,000? today (t=0) at t=T 5 - deposit in GBP and short GBP forward - sell GBP now and deposit in USD FX Forwards & Futures: • No-arbitrage pricing of FX forward: You get USD (\$) in the end (t=T) so for no arbitrage \$ [1,000.e Rf.T ].F 0,T = \$ [1,000].S 0 .e R.T 6 F 0,T = S 0 . e R.T / e Rf.T F 0,T = S 0 . e (R-Rf).T Like before, GBP forward price (F 0,T ) is spot price (S 0 ) plus net cost (r-r f ) to hold it to maturity (T) FX Forwards & Futures: •Examp le: spot rate S 0 = \$1.50 [means GBP 1 = USD 1.5] r = 5% interest rate in USD r f = 10% interest rate in GBP 7 What is the one year (T=1) GBP/USD forward rate? F 0,i = http://markets.ft.com/markets/overview.asp 8
3 Let’s price EUR 1-YEAR FORWARD using interest rates… http://markets.ft.com/markets/overview.asp 9 S = r 3M = r 3M,f = F 0,3m = • Usually, futures prices of Japanese Yen and Swiss Franc increase with maturity, but reverse for other currencies? 10 … this changed after current 2007-08 credit crisis, why? The Yield Curve : There isn’t just one interest rate: there are different rates for different times to maturity …and the yield curve changes every day! Interest Rates – The Basics: 11 http://www.smartmoney.com/investing/bonds/the-living-yield-curve-7923 Interest Compounding : Quoted interest rates are usually annualized with an implicit compounding convention.

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## This note was uploaded on 02/23/2011 for the course FBE 459 taught by Professor Matos during the Spring '08 term at USC.

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FBE459_1_3_Interest_Rate_Futures - Lecture Outline FBE 459...

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