QA Bank 3 Question 4

Discussion in 'SP5' started by april2105, Feb 5, 2013.

  1. april2105

    april2105 Member

    Hi,
    I wonder could someone tell me why the solution assumes we're looking for a quarterly rate?
    Also do we need to take into account the price quoted was for 3 years anywhere in the solution?
    Sorry but my CT1 days are long gone so I'm a bit rusty on this material.

    Also for part ii why do we assume the contracts cost 10,000 each?

    Thanks!
     
    Last edited by a moderator: Feb 5, 2013
    april2105, Feb 5, 2013
    #1
  2. Colin McKee

    Colin McKee ActEd Tutor Staff Member

    quarterly

    Hi, The short interest rate future always refers to a "90 day period". That 90 days can start at any time, but the forward rate always refers to a 90 day period, so the annual rate is by custom, a quarterly compounding rate.
    The 10,000 comes from the core reading formula for the size of one contract. the core reading says that the US short future has notional size $10,000 (100-0.25(100 - Z)) which is where it originates from.
    And in answer to your 3 year question - in this case no. We dont use that infomation because we are just calculating implied forward rates which dont need that input.
     
    Colin McKee, Feb 11, 2013
    #2
  3. BeckyBoo

    BeckyBoo Member

    I'm still not sure I understand this.

    As the IR future in (i) is a 3 year interest rate future I don't see how we could have realised that the implied interest rate is convertible quarterly.
     
    BeckyBoo, Feb 27, 2013
    #3
  4. BeckyBoo

    BeckyBoo Member

    Sorry, pressed soon too quickly!

    I'm also confused about why the 3 year term doesn't come into the solution... If the effective annual IR is 5.074%, isn't a price of 95.29% far too high... Possibly this is a problem of my lack of understanding of the fundamentals of IR futures?!
     
    BeckyBoo, Feb 27, 2013
    #4
  5. Colin McKee

    Colin McKee ActEd Tutor Staff Member

    quarterly compounding

    Hi. All rates implied from short interest rate futures will be quarterly compounding annual rates of return. Because all short interest rate futures relate to a 90 day period. It is just a convention really. If the future is a 3 year future it will relate to period 3 to 3.25. If it is an 8 year future it will relate to 8 to 8.25 etc. So it is always a quarterly compounding rate.
     
    Colin McKee, Mar 3, 2013
    #5
  6. BeckyBoo

    BeckyBoo Member

    Thanks Colin, that makes sense now.
     
    BeckyBoo, Mar 4, 2013
    #6

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