Paper Topic:

Derivatives in Finance and Buyer Behaviuor

Derivatives in Finance and Buyer Behavior

2005

Derivatives in Finance and Buyer Behavior

1 . Futures contract number calculations

Bond characteristics

Maturity 5 Years

Face value USD 10 million

Bond price 99 .50

In to provide the hedging of the bond , it is necessary to find a similar contract at the exchange and buy a certain number of those contracts . One of the major disadvantages of futures hedging is that you might be unable to find the contract which corresponds to the asset which you own . For example , in

the stock exchanges investigated there are no futures contracts on Ford bonds . In to provide the hedging we have to use a contract on some other asset , however it has to be an interest-rate futures contract without fail . For that purpose , we turn to Eurex US which offers a large number of interest-rate contracts Among the contracts which the exchange offers , there are no futures contracts on corporate bonds but there are contracts on US Treasure notes with the face value 100 ,000 . There are contracts with different maturities but we need to choose a contract with the closest maturity to the bond which we have- 5 years . There is a 5-year US Treasure Futures Contract (FTNM ) in the exchange , so we are going to hedge with its help There are no other contracts available on this exchange , as well as on CBOT . Therefore , FTNM is the most appropriate contract to hedge with Currently , the futures contracts on a 5-year US Treasure Futures Contract trade at 107 ,03 , so we need to take that into consideration during the calculation

We obtain the following data

Bond price 9 ,950 ,000

Maturity : 5 Years

Face value of futures contract 100 ,000

Futures contract value 107 ,030 Therefore , we need 93 5-year US Treasure Futures Contract in to hedge the position we have . It would be more appropriate to hedge with futures contracts on the exact type of bonds which we have but in such a case we would need to enter into a forward contract which can be fine-tuned according to our exact needs . With a futures contract , the conditions of the agreement are not as flexible , so we have to use futures contract on US Treasure bonds

We could buy fewer futures contracts in case we did not need the hedge ratio to equal 100 and to accept some interest rate risk in exchange for a possibility of further profits . In such a case , we could buy 50 of the contracts (47 ) and expect the favorable change in interest rates in the future . Even though futures contracts do not provide as much flexibility as some other types of derivatives (those which are traded in OTC market , there is always a possibility to hedge according to the hedge ration which you would prefer

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