can someone plz explain why products (eg term deposits or mortgages) that are sensitive to interest rates should be hedged differently than products that are not sensitive to rates? if so how should they each be hedged? thanks so much in advance!
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Bring me a #11 w/no tomatos son. Futures: Require daily account settling Forwards: Don’t require daily settling Because of this, assets that have positive correlation with interest rates would prefer futures (when values decrease because of rates, the opportunity cost or funding cost decreases and vis-a-versa). Assets with negative correlation (like bonds, for example - which decrease in value when rates rise), prefer forwards, as to avoid daily settling and the requirement to raise cash when asset values are depressed and/or borrowing costs are higher. I think…
The main difference is from DURATION (sensitivity to changes in interest rates)… Look further into duration and it will really help explain this topic for you… an interesting topic to read is Duration Gap and Interest Rate Immunization (especially important with financial institutions to eliminate exposure to interest rate risk)…Duration Gap approaching zero would be ideal for FIs… If you’re looking for low interest rate sensivity, considering investing in a bond with high coupon payments, lower time to maturity… Zero coupon bonds and long term bonds are highly sensitive to changes in interest rates… I don’t agree with JCole’s statement regarding the idea that it has to do with Futures and Forwards…Sure, the differences are obvious…but there are so many possiblities for both that you can say “assets wth positive correlation with rates prefer futures”… Feel free to argue with my statements! (it’s all on the top of my head, and I like an arguement)
MFIN— Wrote: ------------------------------------------------------- > The main difference is from DURATION (sensitivity > to changes in interest rates)… > > Look further into duration and it will really help > explain this topic for you… > > an interesting topic to read is Duration Gap and > Interest Rate Immunization (especially important > with financial institutions to eliminate exposure > to interest rate risk)…Duration Gap approaching > zero would be ideal for FIs… > > If you’re looking for low interest rate sensivity, > considering investing in a bond with high coupon > payments, lower time to maturity… > Zero coupon bonds and long term bonds are highly > sensitive to changes in interest rates… > > I don’t agree with JCole’s statement regarding the > idea that it has to do with Futures and > Forwards…Sure, the differences are > obvious…but there are so many possiblities for > both that you can say “assets wth positive > correlation with rates prefer futures”… > > Feel free to argue with my statements! (it’s all > on the top of my head, and I like an arguement) Ha- that’s an additional and probably more critical component to the question at hand. The futures and forwards preference can be debated with CFAI - that’s what their LII text with respect to the concept indicates (if my top of the head recollection was in the ballpark, solely on rate-sensitive commodities preference within the future/forward contract debate - I think using a duration-minded approach with sensitivity for the factors I talked about would be the way to go).