Eurodollar futures, T Bill futures, Fixed Income futures tough, reason, against

PieMan

I seem to have a tough time understanding when to go long these and when to go short. Can anyone explain? What does each one hedge against?

Caps and floor and swaps/swaptions im good with. For some reason these trip me up.

tikfed

This is a problem area for me too. In your example why would you win if rates go up wouldn't your bond value decrease?

mengxu

ok i think ive understood this topic. Eurodollar futures are quoted as a discount yield. If the LIBOR Drops, the value of the Eurodollar goes up (this is kind of like a bond and interest rates). SO if you are hedging something from dropping interest rates, you would go long a eurodollar future because it would increase in value if the predicted decrease in rates occurs.

Caps and floors are are also used for hedging. If you have a floating rate asset, you are worried about decreasing rates. Therefore, you buy a floor and if rates drop you get a payment from the short. You could also buy an interest rate put, or a call on a bond (again if rates drop in this case, the bond value would increase and you get payment). If you have a floating rate liability, you are worried about rising rates. Therefore, you can buy a cap or interest rate call. If rates rise, you would get payment from the short. You could also buy a put on a bond. If rates rise, the bond value decreases and you win.

Swanand

Pretty sure I went 1 for 6 on this...I wrote some notes on caps and floors late last night...Might not make any sense but worth a shot...

Interest Rate Derivatives - Hedging using Caps and floors

1. Borrowing Money that has a variable rate (Variable Mortgage loan) - If rates start to increase, I will have to pay more. But, if I enter into a cap, I will limit the amount I will have to pay because eventually the cap will be in the money. The loss by paying extra money as rates rise will be offset by the gain in the cap.

2. Investing in a security that had a variable rate - (Buying a variable bond) - If rates start to decrease, I will not be getting as much income as before. Therefore, I will need to hedge against the decrease in interest rates and buy a Floor. I will be able to limit the amount of lost income because at some point in the future, the floor will be in the money. The loss on the variable interest will be offset by the gain on the Floor.

Interest Rate Collar - Enter into an agreement with a caplet and a floor.

1. Borrowing Money - Long Cap, Short Floor - I will great a "Collar" that will let me keep my borrowing costs between a certain range.

2. Hedging against a Liability - Long put, Short Cap - I will be able to keep the returns between a specific "Collar"



Edited 1 time(s). Last edit at Sunday, May 29, 2011 at 01:49PM by beingthatguy.

scarecrow

nvm i got it



Edited 1 time(s). Last edit at Thursday, June 9, 2011 at 05:42AM by mr_moose.