Derivatives

CHAPTER 11Interest Rate Futures

Aims

• To discuss contract specifications, settlement procedures and price quotes for futures contracts on 3-month Sterling deposits, 3-month Eurodollar deposits and US T-bills.
• To show how interest rate futures contracts are priced.
• To examine arbitrage strategies using the implied repo rate on T-bill futures.
• To examine speculation and spread trades using interest rate futures.

Interest rate futures (IRF) became of increasing importance in the late 1970s and early 1980s when the volatility of interest rates increased dramatically. This was because of high inflation and consequent attempts by Central Banks to control the money supply and exchange rates by altering interest rates. Corporates have bank loans and bank deposits based on floating (LIBOR) interest rates and many financial institutions hold short-term fixed income assets (e.g. T-bills, Commercial bills). Interest rate futures contracts are used to hedge risks due to changes in interest rates (yields) which affect the market value of ‘interest sensitive’ cash market assets held by corporates, mutual funds, hedge funds and pension funds.

In the US, Eurodollar futures (CME/IMM) are one of the most actively traded contracts – much more so than EuroYen and US T-bill futures. The contract specification for 3-month Sterling futures (on Euronext), Eurodollar futures (CME/IMM) and US T-bill futures are given in Table 11.1.

TABLE 11.1 Contract specifications

Sterling 3-month (NYSE-Euronext, ...