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Problem 6.26.
Assume that a banA can borrow or lend money at the same interest rate in the 6&7(8 marAet.
The $0*day rate is 10% per annum! and the 120*day rate is 10."% per annum! both
e3pressed with continuous compoundin#. The /urodollar utures price or a contract
maturin# in $1 days is )uoted as 2$.5. +hat arbitra#e opportunities are open to the banA%
The .ur!d!llar "utures c!ntract price !" 89.# &eans that the .ur!d!llar "utures rate is 10.#*
per annu& with (uarterly c!&p!unding and an actual@3$0 day c!unt. This bec!&es
10 # 3$# 3$0 10 $4$% . / . with an actual@actual day c!unt. This is
4ln+1 0 2# 0 10$4$, 0 10#1 + . . .
!r 10.#1* with c!ntinu!us c!&p!unding. The "!rward rate gi)en by the 901day rate and the
1801day rate is 10.4* with c!ntinu!us c!&p!unding. This suggests the "!ll!wing arbitrage
!pp!rtunity;
1. 4uy .ur!d!llar "utures.
2. 4!rr!w 1801day &!ney.
3. -n)est the b!rr!wed &!ney "!r 90 days.
Problem 6.2.
A -anadian company wishes to create a -anadian 6&7(8 utures contract rom a U.S.
/urodollar utures contract and orward contracts on orei#n e3chan#e. Usin# an e3ample!
e3plain how the company should proceed. @or the purposes o this problem! assume that a
utures contract is the same as a orward contract.
The =.0. .ur!d!llar "utures c!ntract &aturing at ti&e T enables an in)est!r t! l!c/ in the
"!rward rate "!r the peri!d between T and
T
where
T
+
where A is the principal a&!unt. T! c!n)ert these t! :anadian d!llar cash "l!ws, the
:anadian c!&pany &ust enter int! a sh!rt "!rward "!reign e2change c!ntract t! sell
:anadian d!llars at ti&e T and a l!ng "!rward "!reign e2change c!ntract t! buy :anadian
d!llars at ti&e
T
. 0upp!se @ and
@
. +These represent the nu&ber !" :anadian d!llars per =.0. d!llar., The
:anadian d!llars t! be s!ld at ti&e T are
H+ , r T T
Ae @
and the :anadian d!llars t! be purchased at ti&e
T
are
A@
The "!rward c!ntracts c!n)ert the =.0. d!llar cash "l!ws t! the "!ll!wing :anadian d!llar
cash "l!ws;
H+ ,
at ti&e
at ti&e
r T T
Ae @ T
A@ T
+
This is a :anadian d!llar I-4'5 "utures c!ntract where the principal a&!unt is
A@
.
Problem 6.2!.
The utures price or the June "011 bond utures contract is 112*"'.
a. -alculate the con,ersion actor or a bond maturin# on January 1! "0"7! payin# a
coupon o 10%.
b. -alculate the con,ersion actor or a bond maturin# on (ctober 1! "0'"! payin#
coupon o 7%.
c.Suppose that the )uoted prices o the bonds in <a> and <b> are 11$.00 and 1'1.00!
respecti,ely. +hich bond is cheaper to deli,er%
d. Assumin# that the cheapest to deli,er bond is actually deli,ered on June "5! "011!
what is the cash price recei,ed or the bond%
a, 'n the "irst day !" the deli)ery &!nth the b!nd has 1# years and 7 &!nths t! &aturity.
The )alue !" the b!nd assu&ing it lasts 1#.# years and all rates are $* per annu&
with se&iannual c!&p!unding is
31
31
1
# 100
140 00
1 03 1 03
i
i
+ .
. .
0ubtracting the accrued interest !" 1.7#, this bec!&es 111.91. The c!n)ersi!n "act!r is
there"!re 1.1191.
c, %!r the "irst b!nd, the (u!ted "utures price ti&es the c!n)ersi!n "act!r is
118.7187#C1.4000 B 1$$.20$3
This is 2.7938 less than the (u!ted b!nd price. %!r the sec!nd b!nd, the (u!ted
"utures price ti&es the c!n)ersi!n "act!r is
118.7187#C1.1191 B 132.8#7$
This is 3.1418 less than the (u!ted b!nd price. The "irst b!nd is there"!re the cheapest
t! deli)er.
d, The price recei)ed "!r the b!nd is 1$$.20$3 plus accrued interest. There are 17# days
between January 1, 2010 and June 2#, 2010. There are 181 days between January 1,
2010 and July 1, 2010. The accrued interest is there"!re
8343 . 4
181
17#
#
The cash price recei)ed "!r the b!nd is there"!re 171.040$.
Problem 6.2"
A portolio mana#er plans to use a Treasury bond utures contract to hed#e a bond portolio
o,er the ne3t three months. The portolio is worth $100 million and will ha,e a duration o
9.0 years in three months. The utures price is 1""! and each utures contract is on $100!000
o bonds. The bond that is e3pected to be cheapest to deli,er will ha,e a duration o $.0 years
at the maturity o the utures contract. +hat position in utures contracts is re)uired%
a. +hat ad4ustments to the hed#e are necessary i ater one month the bond that is e3pected
to be cheapest to deli,er chan#es to one with a duration o se,en years%
b. Suppose that all rates increase o,er the three months! but lon#*term rates increase less
than short*term and medium*term rates. +hat is the eect o this on the perormance o
the hed#e%
The nu&ber !" sh!rt "utures c!ntracts re(uired is
100 000 000 4 0
3$4 3
122 000 9 0
, , .
.
, .
5!unding t! the nearest wh!le nu&ber 3$4 c!ntracts sh!uld be sh!rted.
a. This increases the nu&ber !" c!ntracts that sh!uld be sh!rted t!
100 000 000 4 0
4$8 4
122 000 7 0
, , .
.
, .
!r 4$8 when we r!und t! the nearest wh!le nu&ber.
b. -n this case the gain !n the sh!rt "utures p!siti!n is li/ely t! be less than the l!ss !n
the l!ss !n the b!nd p!rt"!li!. This is because the gain !n the sh!rt "utures p!siti!n
depends !n the si6e !" the &!)e&ent in l!ng1ter& rates and the l!ss !n the b!nd
p!rt"!li! depends !n the si6e !" the &!)e&ent in &ediu&1ter& rates. Durati!n1based
hedging assu&es that the &!)e&ents in the tw! rates are the sa&e.