Futures


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Interest Rate Futures and Valuation


An interest rate futures is a futures contract between the buyer and seller to deliver an interest bearing asset, that allows the buyer and seller to lock in the price of the interest bearing asset for a future date. The most popular interest rate futures is Eurodollar futures.


1. Futures Introduction

Eurodollar futures contract is a cash-settled futures contract. The underlying instrument in Eurodollar futures is a Eurodollar time deposit having a principal value of $1,000,000 with a three-month maturity. Eurodollar futures prices are expressed numerically using 100 minus the implied 3-month U.S. LIBOR interest rate. In this way, a Eurodollar future price of $98 reflects an implied settlement interest rate of 2%.

Interest rate futures are used to hedge against interest rate risk. Investors can use Eurodollar futures to secure interest rates for money it plans to borrow or lend in the future.


2. Futures Valuation

The price of an interest rate future is quoted by the exchange. Thus, a model is mainly used for calculating sensitivities and managing market risk. The present value of an IR future contract is given by

Interest rate futures valuation in FinPricing
  • F_T=100-y(t:T,T_u) – future contract price at the valuation date
  • t – valuation date
  • T – maturity date of the future contract
  • T_u – maturity date of the underlying rate, usually T_u=T+3month
  • y(t:T,T_u ) – annually compounded forward yield for forward period (T, T_u)
  • n – contract size
  • F_o – quoted future contract price at the trade date T_0, T_0≤t≤T

Practical Notes

  • You need to construct yield curve by bootstring some most liquidity interest rate instruments. FinPricing provides useful tools to build various curves, such as interest rate swap curve, basis curve, OIS curve, bond curve, treasury curve, etc. Go to the list of the tools
  • The forward yield is derived from the interest rate zero curve by calculating the annually compounded forward rate between the maturity date of the futures contract and the maturity date of the underlying rate.
  • Theoretically a convexity adjustment is needed for pricing a future contract. However, the impact is small.

References