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Chapter 6Interest Rate Futures
Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 1
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OverviewIntroduce Treasury bond futures and Eurodollars futures used to hedge against interest rate movements.Introduce the Duration which measures how sensitive a portfolio is to interest rates and can also be used with interest rate futures contracts to hedge a company’s interest rate movements.
Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 2
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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 4
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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 5
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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 6
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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 7
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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 9
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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 10
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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 11
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Conversion Factor The conversion factor for a bond is
approximately equal to the value of the bond on the assumption that the yield curve is flat at 6% with semiannual compounding
Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 12
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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 13
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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 14
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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 15
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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 16
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CBOT T-Bonds & T-NotesFactors that affect the futures price:
Delivery can be made any time during the delivery monthAny of a range of eligible bonds can be delivered
Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 17
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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 18
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Eurodollar Futures continuedA Eurodollar futures contract is settled in cashWhen it expires (on the third Wednesday of the delivery month) the final settlement price is 100 minus the actual three month Eurodollar deposit rate
Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 19
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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 20
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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 21
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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 22
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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 23
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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 24
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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 25
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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 27
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Convexity Adjustment when =0.012 (page 145)
Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 28
Maturity of Futures (yrs)
Convexity Adjustment (bps)
2 3.24 12.26 27.08 47.5
10 73.8
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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 29
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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 30
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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 31
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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 32
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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 33
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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 34
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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 35
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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 36
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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 37
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Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 38
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Limitations of Duration-Based Hedging
Assumes that only parallel shift in yield curve take placeAssumes that yield curve changes are smallWhen T-Bond futures is used assumes there will be no change in the cheapest-to-deliver bond
Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 39