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Martinghoul
Registered: Jan 2009
Posts: 5641 |
08-25-12 04:11 PM
Quote from Steven.Davis:
By forward, I meant a Forward Rate Agreement.
Yes, I know what you meant. As I said, a Eurodollar contract is an IMM-dated, exchange-traded FRA (with a fixed notional and slightly different margining arrangements). There's absolutely no reason to bring FRAs into this, in the context of the example provided. It's not going to achieve anything that the Eurodollar contracts don't give you already.
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saminny
Registered: Jun 2008
Posts: 77 |
08-25-12 09:12 PM
Quote from Martinghoul:
The loan in question (the $3mil cash payment) is like a bond. That's the reason why you need to do a strip, rather than a single contract. This has nothing to do with playing the yield curve, cash flow streams, or long-term interest rates. And the Eurodollar future is a forward already.
Thanks.
I thought more about it and it makes more sense now. I am trying to lock in the present value of the bond that is based on current interest rate curve. Each Eurodollar future in this bundle/strip of futures allow me to hedge the interest rate risk for a 3 month period. When I chain them all together, I am hedged for the period from Sep 2007 to Dec 2008. However, because Eurodollar only offers limited quarterly expirations, I am still exposed to interest rate movements from July to Sep 2007, and if I understand correctly, this is where the residual 3 month duration comes from. I could use the monthly serial contracts to further decrease the duration from 3 month to 1 month. Am I on the right track?
I understand due to convexity bias and margining effect, there is difference between the actual forward price and eurodollars futures price. But I am only using this example to get a conceptual understanding before I delve into these practical issues.
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Martinghoul
Registered: Jan 2009
Posts: 5641 |
08-25-12 10:02 PM
Quote from saminny:
Thanks.
I thought more about it and it makes more sense now. I am trying to lock in the present value of the bond that is based on current interest rate curve. Each Eurodollar future in this bundle/strip of futures allow me to hedge the interest rate risk for a 3 month period. When I chain them all together, I am hedged for the period from Sep 2007 to Dec 2008. However, because Eurodollar only offers limited quarterly expirations, I am still exposed to interest rate movements from July to Sep 2007, and if I understand correctly, this is where the residual 3 month duration comes from. I could use the monthly serial contracts to further decrease the duration from 3 month to 1 month. Am I on the right track?
I understand due to convexity bias and margining effect, there is difference between the actual forward price and eurodollars futures price. But I am only using this example to get a conceptual understanding before I delve into these practical issues.
Yes, you are definitely on the right track.
Think of everything you do in rate space as a loan. In the example given the trader has an 18 month loan starting today (spot loan or a bond). The idea of the Eurodollar hedge is to offset this spot loan with a "chain" of back-to-back forward loans. That forward vs spot idea is what the example is attempting to illustrate (although they should make it more clear).
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