A2011, q5 (iii)

[Jimmy white]

Hi,

Part (iii) mentions that an investment in government bonds has lower Market risk than an investment in CDS and futures.

I would have considered this the other way around as the government bonds are heavily exposed to interest rate risk while the downside risk on derivatives are protected by the maintenance margins even though it is highly leveraged. Am I missing something?

 

[andy orodo]

Hi,

Part (iii) mentions that an investment in government bonds has lower Market risk than an investment in CDS and futures.

I would have considered this the other way around as the government bonds are heavily exposed to interest rate risk while the downside risk on derivatives are protected by the maintenance margins even though it is highly leveraged. Am I missing something?

I think that it's a question of the scale of the risk. The interest rate risk is not going to alter the value of the bond as much as the market risks for CDS and futures due to their high levels of gearing, despite the maintenance margin being there.

 

[didster]

I don't see your point about the maintenance margins.

The gain or loss from a future is the difference between the eventual market price at your future date and the price you agreed to pay/accept. This in itself is volatile.

The maintenance margins just accelerate the payment of the ultimate gain/loss.

(Unless you're comparing say 20 year bonds to 30 day futures, where the uncertainty over the much longer long term may outweigh the other factors.)

 

[Jimmy white]

I don't see your point about the maintenance margins.

The gain or loss from a future is the difference between the eventual market price at your future date and the price you agreed to pay/accept. This in itself is volatile.

The maintenance margins just accelerate the payment of the ultimate gain/loss.

(Unless you're comparing say 20 year bonds to 30 day futures, where the uncertainty over the much longer long term may outweigh the other factors.)

The point is that unless you top up with variation margin then the contract will be closed out before maturity. As a result, say you have a long future and there is a sharp fall in the market value of the asset, the margin account gets marked to market and falls below the maintenance margin line,which effectively closes out the contract before maturity unless variation margin is posted. As a result, you are protected by this margin as this is your maximum loss on q contract.

 

[Colin McKee]

Margin

Hi, I think what would happen is that the clearing house would ask you to top up the account, and if you didnt they would close the account and take away your margin. However if there were further losses they would come after you for thise as well. So I doubt you can see the margin as the maximum loss you can make.