SWAPS, FORWARDS, AND FUTURES STRATEGIES

Question 1

describe the use of a forward Rate Agreements (FRAs)

Answer 1

FRA are use to hedge the uncertainty of a future short them borrowing or lending rate

Question 2

What is the pricing convention of Short term interest rate futures

Answer 2

to estimate the price, we do (100 - annualized forward rates).
we can understand from this that a increase in interest rate will lower the price of the position.

Question 3

Explain the two methods that we can based ourselves to identify the CTD bond to price the future contract

Answer 3

Identify the bonds that generate the highest return (implied repo rate)

Identify the bond that offer the lower basis (spot price minus future price)

Question 4

What is the formula to calculate the CTD bond that the short party will need to deliver at the expiry of the future.

Answer 4

The CTD bond that will be deliver is the bond that will generates the highest gain or lowest loss.

Profit/loss on delivery = (settlement price * CF) + Accrued interest) - CTD clean price + AI

Question 5

Explain how do we calculate a change in the futures bond price

Answer 5

Change in CTD price / CF

Question 6

How do we calculate the BPV of a CTD bonds

Answer 6

Duration CTD * 0.0001 * MV

MV = CTD Price / 100 * 100 000$

Question 7

How do we calculate the number of future contract to take to hedge a currency exposure

Answer 7

Currency amount that we want to hedge / futures price

Question 8

Describe the advantages and disadvantages of doing taking a position in an equity swaps rather vs physical stock

Answer 8

Advantages :

• Gain exposure to equity when physical market is restricted
• Avoid tax on physical ownership
• Avoid custody fees
• Avoid the cost of monitoring physical position

Disadvantages :

• Swaps are illiquid
• Typically require collateral
• no voting rights

Question 9

How do we calculate the number of future contract required to achieve a target portfolio beta

Answer 9

((Beta of portfolio - Beta target) / Beta of futures)) * MV portfolio / future contract value

Question 10

What does negative basis means when where referring to futures contract.

Answer 10

It means that the roll yield (spot price minus future price) will be negative. Happens when the market is in contango.

Question 11

how does the difference between implied variance and realized variance impact the outcome for the purchaser of a variance swap?

Answer 11

The purchaser will receive the floating payment and will pay the fixed. In other words, he will take a bet on realized variance vs expected variance. At maturity of the swaps, if realized variance is higher than the variance strike (implied variance), the purchaser will profit.

Question 12

What does variance notional represent

Answer 12

Profit or loss per point difference between the implied variance and realized variance.

Question 13

How can we calculate the variance notional

Answer 13

Variance notional = Vega Notional / 2 * strike price or Nvega * (realized variance - implied variance/ 2 * strike volatility)

Question 14

How does the convexity of variance swap payoffs relative to volatility compare to the linear payoffs of a volatility derivative, and what are the implications of this convexity for the risk-return profile of variance swaps in different volatility environments?

Answer 14

Variance swaps exhibits convexity compare to other volatility derivative. That means that when we are in a increasing volatility environment, payoff on swaps will be higher than on other volatility derivative.

Question 15

Describe what is the federal fund rate

Answer 15

Its the interest rate that deposit institutions charge other institution in the overnight interbank markets.

Question 16

Describe what is the Federal funds target rate.

Answer 16

Thats what we usually are referring to when we are talking about the central bank rates. Important consideration when we are targetting a weight is inflation rates and GDP Growth rate.

Question 17

How can we determine the probability of a change in the Fed funds target rate

Answer 17

Effective rate implied by futures - current fed fund target rate / Fed funds rate assuming a rate change - current fed fund target rate

Question 18

Related to bonds futures, what does positive basis means and how can we profite from it ?

Answer 18

Positive basis means that the bonds is trading higher than the futures, hence the futures is in backwardation. We can profit from this by selling the bonds and buying the futures.