7Lecture8interestrateriskIV

5 years nf e f dff r1r 53 problems size amount

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Unformatted text preview: ck at lower price if rates increase Solving for the Number of futures contracts “NF”? Δ F = - DF * F * Δ r/(1+r) NF*BF 51 Solving NF such that ΔF = ΔE - DF * NFBF * Δ r/(1+r) = - [DA - DL * (L/A)] *A *Δr/(1+r) Assume : Equal NF = [ DA – DL (L/A) ] A DF * B F 52 Futures Market BF = 97, Par = 100K, DF= 9.5 years NF = ΔE = Δ F=-DF*F*Δ r/(1+r) 53 Problems • Size? Amount of Futures cannot be tailored exactly to the amount we want to hedge • Timing? Differences in the timing of CF from the futures and the position to be hedged • Regulation? Some countries limit the use of futures ►Basis Risk? Δr in Spot # Δr in Futures 54 Case 2 Control the Basis Risk Δ r in Spot ≠ Δ r in Futures Δr/(1+r) ≠ ΔrF/(1+rF) Hedged if ΔF = ΔE - DF*(NFBF)* Δ rF/(1+rF) = - [DA - DL * (L/A)] *A *Δr/(1+r) h= Δr/(1+r)/ΔrF/(1+rF) NF = [ DA – DL (L/A) ] A * h DF * B F 55 Example Assume h = .9 NF = 56 C. Hedging using Interest Rate Options Types Buyer Seller Call option Right to buy Obligation to sell Put option Right to sell Obligation to buy Underlying option ~Bond (B ) Exercise Price ~E Expiration date Price of the option ~ C / P American vs European 57 Interest Rate Options B< E B=E Long Call Short Call -C +C -C +C Long Put Short Put - P +(E-B) -P +P + P+(B-E) B>E - C + (B-E) + C + (E-B) -P +P Zero sum game 58 Call Options on Bonds Buy a call Wri...
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This note was uploaded on 03/12/2014 for the course FINE 442 at McGill.

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