Please can someone give me an intuitive explanation for the contract price of an interest rate future (chapter 11): It states that the contract price is 10,000 [100-0.25(100-Z)] What does the 10,000 refer to? (100-Z) would be the difference between the nominal and quoted price. I understand this is multiplied by 0.25 because to make it 3 monthly. Why is this subtracted by 100 again and then multiplied by 10,000? Thanks.
Y'llo abumenang, I am a ST6 student and your formula is for a specific interest rate future called a Eurodollar future. These trade at a discount against the LIBOR. Note that the LIBOR is NOT compounded therefore, we use simple interest. To be accurate Eurodollar futures are a way of hedging by fixing interest rates on a notional of 1000 000. 'Two minutes of Google will expand'....let me explain the math;- Suppose you bought a Eurodollar future, then you are lending 1000 000 at a discount, suppose the 3-month futures quote is 96.5, then the LIBOR is 3.5%. Thus you are lending 1000 000(1-0.25*Libor%) This can also be written as 1000 000 - 10 000*0.25*(100-96.5). Note that 100 - 96.5 = LIBOR*100. Factorising 10000 gives;- 10000(100 - 0.25*(100-Q))
