Forward and future quiz 2 - Eurodollar Futures

naresh.thkr
Good Student
Posts: 25
Joined: Sat Aug 11, 2012 7:02 pm

Forward and future quiz 2 - Eurodollar Futures

Postby naresh.thkr » Sat Nov 10, 2012 8:31 pm

Roughly how many three-month LIBOR Eurodollar futures contracts are needed to hedge a position in a $200 million, 5-year receive-fixed swap?
Choose one answer.
a. Long 250
b. Short 3,200
c. Short 250
d. Short 40,000
The correct answer is short 3,200.

The dollar duration of a 5-year 6% par bond is about 4.3 years. Hence the DVBP of the position is about $200,000,000 × 4.3 × 0.0001 = $86,000. That of the futures is $25. Hence the ratio is 86,000/25 = 3,440.

Is question incomplete? Can anyone give a try.

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content.pristine
Finance Junkie
Posts: 356
Joined: Wed Apr 11, 2012 11:26 am

Re: Forward and future quiz 2 - Eurodollar Futures

Postby content.pristine » Mon Nov 12, 2012 3:52 pm

Hi.
This question is correct.
You need to know duration hedging to answer the question.
The total risk of the swap should equal to the total risk of the euro-dollar futures.

The duration of a par 5 year swap is 4.4 years. You can get the answer also by using my duration approximation formula = 75% of maturity.. That gives 3.75 years. (the options give me enough room for approximations when duration not given in the question).

Now PVBP of the swap = 3.75 (using approximation) * 200 M = 75,000.

Eurodollar futures are highly standardized contract. The face value is always $1M, the tenure is always 3 months. PVBP = $25 (always).. this is a very important concept so remember it for the exam...

Number of eurodollar contracts = 75000/25 = 3,000..
3,200 is the closest answer...

8-)

naresh.thkr
Good Student
Posts: 25
Joined: Sat Aug 11, 2012 7:02 pm

Re: Forward and future quiz 2 - Eurodollar Futures

Postby naresh.thkr » Wed Nov 14, 2012 11:01 pm

Thanks for your detailed answer.

Naresh.


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