Phobos Interest Rate Hedging Mark FieldingPritchard mefielding com

Phobos Interest Rate Hedging Mark Fielding-Pritchard mefielding. com 1

Phobos Wants to borrow money, £ 30 m Loan taken out 1 March, for 4 months Sell March (30 m/0. 5)x (4/3)= 80 On 1 January sell 80 March’s @ 93. 88 On 1 March buy back Note. On 1 January Libor is 6%, therefore the price of a future should be 94. But it isn’t, it is 93. 88, therefore we have basis risk of 0. 12% (12 ticks) mefielding. com 2

Phobos Decline of Basis Risk 6, 14 You need to calculate the decline in basis risk to get the value of the future on close out 6, 12 6, 1 6, 08 6, 06 Basis risk 1 Jan 12 basis points 6, 04 6, 02 6 6 Basis risk 1 Mar 4 basis points 5, 98 5, 96 5, 94 1 -янв mefielding. com 1 -фев 1 -мар 1 -апр 3

Phobos So basis risk will be 3 basis points from LIBOR at 1 March for a March future Implied interest is greater than LIBOR so future price will be below expected mefielding. com LIBOR Future Price 7% 92. 96 5% 94. 96 4

Phobos LIBOR 5% (Additional)/ Saved Interest 100000 (100000) Future Sold 93. 88 Buy 94. 96 Loss 108 Sold 93. 88 Buy 92. 96 Gain 92 Gain/ Loss 1. 08% x £ 500000 x 3/12 x 80 (108 ticks x 12. 50 x 80= 108000) 0. 92% x £ 500000 x 3/12 x 80 (92 ticks x 12. 50 x 80= 92000) Hedge Efficiency 100000/108000= 92. 6% 92000/100000= 92% mefielding. com 7% 5

Phobos- Options are just options to buy or sell futures With futures we sold 80 March so here we want 80 March puts Which exercise price? And what is the premium cost? Strike Interest Premium 93750 6250 45 6. 295 94000 6000 168 6. 168 94250 5750 300 6. 050 Therefore we buy on 1/1 80 March puts, premium cost 0. 3% x 500000 x 3/12 x 80 = £ 30000 (30 x 12. 5 x 80= £ 30000) mefielding. com 6

Phobos LIBOR 5% (Additional)/ Saved Interest 100000 (100000) Future Sold 94. 25 Buy 94. 96 Don’t exercise Sold 94. 25 Buy 92. 96 Gain 129 Gain/ Loss Premium £ 30000 1. 29% x £ 500000 x 3/12 x 80= 128000 (129 ticks x 12. 50 x 80= 129000) mefielding. com 7% 7

Phobos LIBOR 5% (Additional)/ Saved Interest 100000 Future Gain of £ 100000 becomes net loss of Loss of £ 100000 reduced by gain £ 8000 of £ 92000 Option Gain of £ 100000 reduced by premium of £ 30000 mefielding. com 7% (100000) Loss of £ 100000 becomes loss of £ 1000 8

Phobos Potentially interest rates can rise and rise, UK 22% Selling puts is risk without limits Our numbers don’t include costs SWAPS can build in risk for years Basis risk means there are under/over hedged liabilities Derivatives should not be used for speculating mefielding. com 9