financial 6

Module 6 Critical Thinking: Financial Futures & Interest-Rate Options (100 points)

1. Assume that Blue Sunday Bank has $200 million of assets with an average duration of 1.6 years and liabilities of $100 million with an average duration of 1.95 years. Compute the current duration gap of this bank. Assuming that U.S. Treasury bonds with a duration of 1.2 years are currently quoted in the market at 98-16, explain the position (buy or sell) in a futures contract (including the number of contracts) that the bank manager should take to eliminate interest rate risk.

The following quotes will be used for the next two parts of this problem.

5-Year U.S. Treasury Bond Futures Contract Quotes from 6/27/2013

CBT $100,000; pts 32nd of 100%

Month	Last	Change	Prior Settle	Open	High	Low	Volume	Updated
Jun 2013	121'240 a	+0'102	121'137	121'220	121'250 b	121'210	92	4:15:23 PM CT 6/27/2013
Sep 2013	121'015 b	+0'112	120'222	120'237	121'030	120'210	666,982	4:15:23 PM CT 6/27/2013

Source: CME Group. (2013, June 27). 5-year U.S. Treasury note futures. Retrieved from http://www.cmegroup.com/trading/interest-rates/us-treasury/5-year-us-treasurynote_quotes_globex.html#prodType=AME

Eurodollar Future Contracts Quotes on 6/27/2013

CME - $100,000; pts of 100%

Month	Last	Change	Prior Settle	Open	High	Low	Volume	Updated
Jul 2013	99.7225	+0.0025	99.72	99.7225	99.7250	99.7200	9,880	4:06:35 PM CT 6/27/2013
Aug 2013	99.710 b	+0.015	99.695	99.700	99.710	99.700	3,290	4:06:35 PM CT 6/27/2013
Sep 2013	99.685 b	+0.020	99.665	99.675	99.690	99.670	98,488	4:06:35 PM CT 6/27/2013
Oct 2013	99.665	+0.020	99.645	99.660	99.665	99.655 a	21	4:06:35 PM CT 6/27/2013

Source: CME Group. (2013, June 27). Eurodollar futures. Retrieved from http://www.cmegroup.com/trading/interest-rates/stir/eurodollar_quotes_globex.html

2. Ignoring your work from Part 1, assume that the manager chooses to hedge the bank’s risk by buying (long) twenty 5-year U.S. Treasury bond futures contracts with an expiration of

September, 2013. Use the quotes given in the table above where the contract price is the “Last” quote and the apostrophe replaces the dash seen in your textbook. An initial margin is deposited for all contracts as noted in the text. You can ignore any potential margin calls on this problem.

a. If interest rates rise, will the banker’s position be favorable? Why or why not?

b. If at the end of the contract (September 2013), the manager reverses the bank’s position (sells all 20 contracts) and the contract is now quoted at 114’16, how much money was made or lost on the futures contract?

c. Given the initial margin, what is the holding period rate of return (i.e., profit/initial margin)?

3. Use the quotes above 2 for this question also. Ignoring your work from Parts 1 & 2, now assume the bank is in an entirely different position and the manager chooses to hedge the bank’s risk by selling (short) fifteen Eurodollar contracts with an expiration of August 2013. The contract price is the “Last” quote. An initial margin is deposited for all contracts as noted in your textbook. You can ignore potential margin calls on this problem.

a. If at the end of the contract (August 2013), the manager reverses the bank’s position (buys all 15 contracts) and the contract is now quoted at 98.95, how much money was made or lost on the futures contract?

b. Given the initial margin, what is the holding period rate of return?

Below are snippets of the September 2013 option Eurodollar quotes (notice the first set of quotes is for calls and the second is for puts). Note that on the date of these quotes, the Eurodollar future is quoted at 1.30170 or 130.170% of the contract size, which is $1 million. The option prices in these quotes are given as % of $1,000,000. For example, the cost of the 1165 Call option = .1513% of $1,000,000 or $1513.

Use these quotes to compute the profit or loss on the following option positions if when the options expire, the Eurodollar is quoted at 1175 or 117.5% of $1 million. In all cases, you are computing the profit or loss for ONE CONTRACT assuming that the option was purchased (or sold) at the “Last” rate (see bolded column name).

Strike	Session: September 2013 Eurodollar Calls Open High Low Last Time	Pr. Day Set Chg Vol Set Op Int	Expiry
future	1.30430	1.31080	1.29950	1.30170	15:30 Jun 28	1.30230	-0.00290	231530	1.30520	200611
1165	-	-	-	0.15130	16:34 Jun 27	0.13750	-0.00290	-	0.14040	-
1170	-	-	-	0.14690	16:34 Jun 27	0.13260	-0.00290	-	0.13550	-
1175	-	-	-	0.14260	16:34 Jun 27	0.12760	-0.00300	-	0.13060	-
1180	-	-	-	0.13840	16:34 Jun 27	0.12270	-0.00300	-	0.12570	-
1185	-	-	-	0.13420	16:34 Jun 27	0.11780	-0.00300	-	0.12080	-
1190	-	-	-	0.13000	16:34 Jun 27	0.11300	-0.00300	-	0.11600	-
1195	-	-	-	0.12590	16:34 Jun 27	0.10820	-0.00290	-	0.11110	-

Strike	Session: September, 2013 Puts		Pr. Day	Expiry
Open	High	Low	Last	Time	Set	Chg	Vol	Set	Op Int
future	1.30430	1.31080	1.29950	1.30190	15:31 Jun 28	1.30230	-0.00290	231530	1.30520	200611
1160	0.00030	0.00030	0.00030	0.00030	09:11 Jun 28	0.00030	-0.00005	9	0.00035	412
1165	-	-	-	0.00045	16:34 Jun 27	0.00035	-0.00005	-	0.00040	22
1170	0.00040	0.00060	0.00040	0.00060	13:15 Jun 28	0.00045	-0.00005	21	0.00050	356
1175	-	-	-	0.00070	16:34 Jun 27	0.00050	-0.00010	-	0.00060	85
1180	0.00060	0.00060	0.00050	0.00050	08:04 Jun 28	0.00060	-0.00010	5	0.00070	749
1185	-	-	-	0.00100	16:34 Jun 27	0.00070	-0.00010	1	0.00080	301
1190	0.00070	0.00070	0.00070	0.00070	08:03 Jun 28	0.00090	-0.00010	2	0.00100	328
1195	0.00100	0.00100	0.00100	0.00100	09:46 Jun 28	0.00110	-	10	0.00110	310
1200	0.00100	0.00130	0.00100	0.00130	13:44 Jun 28	0.00130	-	179	0.00130	3711

Option quotes for Eurodollar futures contracts

Source: TradingCharts.com. (2013). Commodities futures price quotes. Retrieved fromhttp://futures.tradingcharts.com/marketquotes/E6.html

Compute the profit or loss assuming the following positions (again, assuming that at maturity Eurodollars are quoted at 1175).

1.You buy a 1165 call. 2.You buy a 1165 put. 3.You buy a 1190 call. 4.You buy a 1190 put.

5.You sell a 1195 call. 6.You sell a 1195 put. 7.You sell a 1170 call. 8.You sell a 1170 put.

Be sure to organize and label your work appropriately and submit only one document for grading. Upload your completed spreadsheet to the Week 6 Assignments page.