7.6 pricing and valuation of futures contracts

Question 1

Contract Type: Interest rate futures

Gains from Rising MRR?

Gains from Falling MRR?

Answer 1

Gains from Rising MRR: Short futures contract

Gains from Falling MRR: Long futures contract

Question 2

Contract Type: Forward rate agreement

Gains from Rising MRR?

Gains from Falling MRR?

Answer 2

Gains from Rising MRR: Long FRA: FRA fixed-rate payer (FRA floating-rate receiver)

Gains from Falling MRR: Long futures contract (FRA floating-rate payer (FRA fixed-rate receiver)

Question 3

The basis point value (BPV) of an interest rate futures contract is

Answer 3

defined as the change in price for a shift of one basis point (0.01%) in the underlying MRR.

Question 4

The prices of a forward contract and a futures contract on the same underlying for the same maturity will only match if the following conditions are met:

Answer 4

The interest rate curve is flat

Futures prices and interest rates are uncorrelated

Question 5

If there is a positive correlation between futures prices and interest rates, a long futures position will be more attractive than an equivalent long forward position.

This is because…

Answer 5

an increase in the price of the underlying will generate profits that can be reinvested at higher interest rates.

–> Conversely, the price of a futures contract will be below that of an equivalent forward contract if futures prices and interest rates are negatively correlated

Question 6

Correlation between Futures Prices and Interest Rates: No Correlation

Outcome With Rising Interest Rates

Answer 6

Futures prices = Forward prices

Question 7

Correlation between Futures Prices and Interest Rates: Positive Correlation

Outcome With Rising Interest Rates

Answer 7

Futures prices > Forward prices

Question 8

Correlation between Futures Prices and Interest Rates: Negative Correlation

Outcome With Rising Interest Rates

Answer 8

Futures prices < Forward prices