*Please utilize info from (a) to answer b-e also show work and or formulas utili
ID: 2807080 • Letter: #
Question
*Please utilize info from (a) to answer b-e also show work and or formulas utilized.*
Question 4. (20 points) A Treasury bond futures contract settles at 103'16.
a. Calculate the present value of one futures contract in dollars?
Current bond Percentage
103.50
103.5%
Present value of future contract
$ 103,500
b. Are current market interest rates higher or lower than the standardized rate on a futures contract? Explain.
c. Calculate the implied annual interest rate on the futures contract.
d. Calculate the new value of the futures contract if interest rates increase by 1 percentage point annually.
e. Describe differences between forward and futures contracts? Illustrate, using a specific example, of how companies could use either a futures or forward contract to hedge a position.
Current bond Percentage
103.50
103.5%
Present value of future contract
$ 103,500
Explanation / Answer
Answer:
b. Since the contract is settled greater than the face value, therefore the current market rates are lower than the standardized rate because lower the interest rates higher the value settled.
c. Annual interest rate = (100 - 103.5)/103.5 * 100 = 3.38%
d. If the interest rate increase by 1%, it would be 103.51
The new value would be $100,000 (103.51) = $103,510
e.
The forward contracts differ from the future contracts. Future contracts are exchange traded and are also standardized contracts whereas Forward contracts are the agreements between the two parties and are flexible in terms and conditions. The settlement of future contracts can occur over range of dates and forward contract has only one settlement date. The forward contract settlement occurs when the contract ends and future contracts are settled on daily basis. In forward contracts, there is always a chance that party may default on the side of the agreement whereas a future contract reduces the probability of default. The Forward contracts are mainly used by hedgers to reduce the volatility of asset’s price whereas future contracts are frequently used by speculators who are close to maturity.
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