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Interest Rates

Example #1. Sell Interest Rates with Futures (short position)

The Futures contract named "Euribor 3 Months, June 09" with 3 Month Euribor as the underlying asset, is traded on London Futures Exchange and has the following characteristics:

  Contract size: 1,000,000 Euros
  Basic points: 25 (0.0025)
  Contract currency: EUR
  Required margin: 900 Euros
  Contract expiration: 15-06-2009

Opening position

On May 3rd, the 3 Month Euribor is at 1.2273%. The Futures contract with 3 Month Euribor as the underlying asset ("Euribor 3 Months, 10 Jun") is trading at 98.7650 (bid) / 98.7750 (ask) for the same date and time. This also means that it is trading at 1.2350 % (bid) / 1.2250 % (ask)  [(100-price) / 100].

The investor expects that the European Central Bank (ECB) will rise interest rates to control inflation, and for this reason he/she sells one Futures contract:

  Exposure: 1,000,000 x 0.0025 x 98.7650 = 246,912.5 Euros
  Required margin: 900 euros

Closing position
Investor's expectations were correct and on 15th June of 2009, 3 Month Euribor has risen to 1.5130 %. On the same date and time the Futures contract is trading at 98.4850 (bid) / 98.4875 (ask), which means 1.5150 % (bid) / 1.5125 % (ask). The investor closes his position and makes a profit.

Trade summary
 

Example 2. Sell Interest Rates with Futures (short position; hedge interest rate rise risk)

You are satisfied with the interest rate you signed for your mortgage and would like to maintain it for the next 2 years, but you fear a sudden rise in interest rates, as it happened during 2007 and 2008. The interest rate of your mortgage is indexed to 3 Month Euribor.

For this reason, you would like to ensure your current interest rate and not be affected by any rise.

To protect your mortgage, you could sell a Futures contract with a 3 Month Euribor as the underlying asset and expiration date in June 2010.

Opening position
On May 11th, the Futures contract "Euribor 3 Months, 10 Jun" is trading at 98.470 (bid) / 98.475 (ask). This means that the implicit interest rate is 1.530 % (bid) / 1.525 % (ask).

You expect the European Central Bank (ECB) to raise interest rates in the coming months, so you decide to sell a Futures contract to hedge this risk:

  Exposure: 1,000,000 euros x 0.0025 x 98.470 = 246,175 EUR
  Required margin: 900 euros

Imagine that in May 2010, as expected, the ECB has risen interest rates to 3.5 % (ECB discount rate).This would mean a yearly increase in your mortgage of approximately 4,200 euros.

Closing position
On May 5th of 2010, 3 Month Euribor is at 3.5530 %. On the same date, the Futures contract is trading at 96.455 (bid) / 96.470 (ask), which means an implicit interest rate of 3.545% (bid) / 3.530% (ask).

You decide to close your position and pocket the profits. The profit would ascend to 5,000 euros = 1,000,000 euros x 0,0025 x (98,470-96,470).

Trading summary