Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Using Financial Futures
and Options in Bank AssetLiability Management
Chapter
8
The purpose of this chapter is to examine how financial futures
contracts can be employed to help reduce a bank’s potential
exposure to loss due to changing interest rates and other forces
in the economy.
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Financial Futures Contract
An Agreement Between a Buyer and a
Seller Which Calls for the Delivery of a
Particular Financial Asset at a Set Price at
Some Future Date
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
The Purpose of Financial Futures
To Shift the Risk of Interest Rate
Fluctuations from Risk-Averse Investors to
Speculators
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
The World’s Leading Futures and Option
Exchanges
Chicago Board of Trade
(CBOT)
 Financial Exchange (FINEX)
 New York Futures Exchange
(NYFE)
 Marche a Terme International
De France (MATIF)
 Singapore Exchange LTD.
(SGX)

Chicago Mercantile
Exchange (CME)
 London International
Financial Futures Exchange
(LIFFE)
 Sydney Futures Exchange
 Toronto Futures Exchange
(TFE)

Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Most Common Financial Futures Contracts
 U.S.
Treasury Bond Futures Contracts
 U.S. Treasury Bill Futures Contracts
 Three-Month Eurodollar Time Deposit Futures
Contract
 30-Day Federal Funds Futures Contracts
 One Month LIBOR Futures Contracts
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Hedging with Futures Contracts
Avoiding Higher
Borrowing Costs and
Declining Asset Values
Avoiding Lower Than
Expected Yields from
Loans and Securities


Use a Short Hedge:
Sell Futures Contracts
and then Purchase
Similar Contracts
Later
Use a long Hedge:
Buy Futures Contracts
and then Sell Similar
Contracts Later
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Basis Risk
Cash-Market Price (or Interest Rate) Less
the Futures-Market Price (or Interest Rate)
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Realized Return from Combining Cash and
Futures Market Trading
= Return Earned in the Cash Market
+/- Profit or Loss from Futures Trading
-
Closing Basis Between Cash and Futures Market
-
Opening Basis Between Cash and Futures Market
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Number of Futures Contracts Needed
TL
(D A - D L *
) * TA
TA

D F * Price of the Futures Contract
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Interest Rate Option
It Grants the Holder of the option the Right
but Not the Obligation to Buy or Sell
Specific Financial Instruments at an
Agreed Upon Price.
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Types of Options
 Put
Option
 Gives
the Holder of the Option the Right to Sell the
Financial Instrument at a Set Price
 Call
Option
 Gives
the Holder of the Option the Right to Purchase the
Financial Instrument at a Set Price
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Most Common Option Contracts Used By
Banks
 U.S.
Treasury Bill Futures Options
 Eurodollar Futures Option
 U.S. Treasury Bond Option
 LIBOR Futures Option
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Principal Uses of Option Contracts
 Protection
of the Bond Portfolio
 Hedging Against Positive or Negative Gap Positions
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.