Professional Documents
Culture Documents
Prepared by
Gady Jacoby
University of Manitoba
and
Sebouh Aintablian
American University of
Beirut
McGraw-Hill Ryerson © 2003 McGraw–Hill Ryerson Limited
25-1
Chapter Outline
25.1 Forward Contracts
25.2 Futures Contracts
25.3 Hedging
25.4 Interest Rate Futures Contracts
25.5 Duration Hedging
25.6 Swap Contracts
25.7 Actual Use of Derivatives
25.8 Summary & Conclusions
• Standardizing Features:
– Contract Size
– Delivery Month
• Daily resettlement
– Minimizes the chance of default
• Initial Margin
– About 4% of contract value, cash or T-bills held
in a street name at your brokerage.
Futures Markets
Canola Futures
• Expiry cycle: January, March, May, July,
September, November.
• First delivery day is the first business day of the
delivery month.
• Last trading day is seven clear business days prior
to the end of the delivery month.
• Trading hours 9:30 a.m. to 1:15 p.m. CT.
F C 1
PV 1 T
(1 r ) T
r (1 r )
McGraw-Hill Ryerson © 2003 McGraw–Hill Ryerson Limited
25-21
C C C CF
PV
(1 r1 ) (1 r2 ) (1 r3 )
2 3
(1 r2T ) T
C C C CF
(1 rN 1 ) (1 rN 2 ) (1 rN 3 )
2 3
(1 rN 2T )T
PV
(1 rN ) N
McGraw-Hill Ryerson © 2003 McGraw–Hill Ryerson Limited
25-23
Futures Contracts
Duration Formula
Calculating Duration
Calculating Duration
Discount Present Years x PV
Years Cash flow factor value / Bond price
COMPANY B BANK A
Fixed rate 11.75% 10%
Floating rate LIBOR + .5% LIBOR
COMPANY B BANK A
Fixed rate 11.75% 10%
Floating rate LIBOR + .5% LIBOR
US$ £
Company A 8.0% 11.6%
Company B 10.0% 12.0%
Swap
Bank US$9.4%
US$8%
£11% £12%
US$8% Firm Firm £12%
A B
US$ £
Company A 8.0% 11.6%
Company B 10.0% 12.0%
£11% £12%
US$8% Firm Firm £12%
A B
A saves £.6%
US$ £
Company A 8.0% 11.6%
Company B 10.0% 12.0%
£11% £12%
US$8% Firm Firm £12%
A B
£11% £12%
US$8% Firm At S0($/£) = $1.60/£, that Firm £12%
A is a gain of US$124,000 B
per year for 5 years.
The swap bank
US$ £ faces exchange rate
Company A 8.0% 11.6% risk, but maybe
Company B 10.0% 12.0% they can lay it off
(in another swap).
McGraw-Hill Ryerson © 2003 McGraw–Hill Ryerson Limited
25-49
• Credit Risk
– This is the major risk faced by a swap dealer—the risk
that a counter party will default on its end of the swap.
• Mismatch Risk
– It’s hard to find a counterparty that wants to borrow the
right amount of money for the right amount of time.
• Sovereign Risk
– The risk that a country will impose exchange rate
restrictions that will interfere with performance on the
swap.
Pricing a Swap