Hedging Specifics

Question 1

How do you calculate the number of contracts for interest rate products?

Answer 1

Loan Size/Contract Size x Duration/3months

Question 2

How do you calculate the number of contracts for Index products?

Answer 2

Portfolio value/(Futures price or strike price x £10)

Question 3

How do you calculate the number of contracts for currency products?

Answer 3

Amount of currency/Contract size - MAKE SURE THEY ARE IN THE SAME CURRENCY

Question 4

How do you determine whether to buy or sell with interest rate products?

Answer 4

Borrowing: SELL FUTURES (Buy Puts)

Lending/Depositing: BUY FUTURES (buy calls)

Question 5

How do you determine to sell or buy index products?

Answer 5

Selling a portfolio: OR Protecting a portfolio
SELL FUTURES: Buy PUT

Buying a portfolio: BUY FUTURES (Call)

Question 6

How do you determine to sell or buy index products?

Answer 6

Selling a portfolio: OR Protecting a portfolio
SELL FUTURES: Buy PUT

Buying a portfolio: BUY FUTURES (Call)

Question 7

How do you determine whether to buy or sell currency products?

Answer 7

Protecting = PUT

Buying $/Euro and selling £ = Sell Futures (buy puts)

Selling $/Euro and buying £ = BUY Futures (Buy calls)

Question 8

How do you calculate a profit or loss on an interest future rate product?

Answer 8

Will be a percentage therefore multiply the outcome by:

3/12 x 500k x no of contracts

Question 9

How do you calculate a profit or loss on an interest future index products?

Answer 9

Will be in points, therefore multiply the outcome by £10 x no of contracts.

E.g. Index goes from 5000 to 4100.

900 x £10 = 9,000
x 112 contracts = £1,080,000 gain

Question 10

How do you calculate a profit or loss on an interest future currency products?

Answer 10

Profit/loss will be in denominated currency per £ therefore multiply by

Contract size x no of contracts

Then translate back to £!

E.g. Futures currently trading at 1.6496
Payment of 1,550,000 dollars

£62,500 contract size

= 1,550,000/1.6496/62,500 = 15 contracts

Future spot = 1.6400

(1.6496 - 1.6400) x 15 x 62,500 = gain

Deduct a gain from a payment/Add a gain to a receipt and then divide by the future spot rate

Question 11

How do you calculate a premium on future interest rate options?

Answer 11

Will be a %, therefore multiply the outcome by

3/12 x 500k x no of contracts

Question 12

How do you calculate a premium on future index options?

Answer 12

Will be in points, therefore multiply the outcome by:
£10 x no of contracts

e.g. the ut premium is 70 points in December =

70 x £10 x number of contracts

Question 13

How do you calculate a premium on currency futures contracts (options only)?

Answer 13

Premium will be in denominated currency per £ therefore multiply by:

Contract size x no of contracts

Then convert back to £!!

Question 14

How do you approach any traded options questions?

Answer 14

Approach to cope with any traded options question:
1 Decide whether to buy a call or a put
2 Decide what expiry date to pick (the next date AFTER you expect to act)
3 Calculate the number of contracts
4 Decide what strike price to choose (therefore what is the premium)
5 Show the calculation (three elements)
£ £
Transaction at the market rate (easy) X/(X)
Futures position
Price now X
Price later X
Profit/Loss X/nil X /nil

× amount per contract × no of contracts

Premium (X)
Overall position X

Question 15

Currency Hedging - Futures and Traded Options - what expiry date do you pick?

Answer 15

The first date AFTER the settlement date (i.e. if the settlement date is mid-May and there are March or June contracts on offer – you need the JUNE contracts).

Question 16

Index hedging - which date do you pick?

Answer 16

The first date AFTER they need to sell (i.e. if they want to protect against prices falling until 10 July, then buy September contracts).

Question 17

Interest rate hedging - Futures and traded options - What expiry date to pick?

Answer 17

Pick the first date AFTER the borrowing/lending starts – e.g. If you need to borrow on 31 March, use March contracts. If you need to borrow on 3 August, use September contracts.