Interest Rate Futures - position take on bond or rate?

CFA Level III
#1

Volume 4 Page 148 Q3.

The company holds bonds and Consultant C suggests selling interest rate futures. The answer says this is a good position to take if you are not sure which way interest rates will move.

So I assume the position is taken on the bond?

If rates go up, bond values go down so he gains on his short position, which hedges his long bond position.

If rates go down. bond values go up so he loses out on gains on his long bond position.

I guess my only question is if it is implied that the position is taken on the bond and also, is it possible to have an interest rate futures position on either the bond or the rate? For example, a put can be taken on a bond position or on an interest rate.

#2

if rates go up - bond position loses, interest rate futures win.

if rates go down - bond position gains, interest rate futures lose.

so overall you are close to where you started out.

I guess here the position is an INTEREST RATE FUTURE.

Put on a Bond would win if Rates went down - since Put would then be ITM. But you pay a premium.

If Rates went up - Put on Bond would be OTM - and you lost the premium.

[Am I losing my mind?]

#3

no youre correct. i wanted to confirm that when we say “interest rate future” in this Q it is implied that your position is on the bond, and not the rate.

but in general interest rate future can be either on the bond or the rate, can’t it?

#4

the direction of movement on a bond would be opposite to that on a rate…

I think in this case - it is on the movement of the rate.

#5

agree that it is opposite to the rate.

dont agree that in this case it is on the movement of the rate. the answer says that the futures position wins when rates go up. he is short interest rate futures. this means he wants bond values (prices) to go down. for bond valus to go down, rates have to go up. so the only way the answer is correct and that he hedges his long bond position is if the short position is taken on the bond, not the rate.

#6

If you sell an interest rate future, you commit to loan at X future rate ?

And if rate go up, future go down ?

(or i loss somthing ?)

#7

CP i think you have it backwards no?

If rates go up, the bond value goes down. A put on the bond is therefore in themoney when rates rise.

If rates go down, the bond value goes up, and the put on the bond would be out of the money.

Or did I misunderstand your post?

#8

I need to think slowly…

I know this is where I mess up a lot of the time.

Put on Bond …

Max (0, X - St) – will be in the money when St < X. So rate goes up - Bond price goes down - yes St will be lower than X.

Thanks for clarifying. I knew there was something off …

and hence

#9

so back to the original question…if we agree that the interest futures position is on the bond here, do we also agree that the position can be taken on either the bond or the interest rate (just like in a put), and they would have to specify which one the analyst is doing?

#10

under what circumstances is the underlying a bond/rate?

#11

Isn’t the general assumption that when they say interest rate future they are referring to a treasury being the underlying?

The only future/fwd I can remember right now that takes a position based on the actual interest rate movement is a credit spread fwd.

Is this incorrect?

#12

interest rate future (IRFs) have underlying as interest bearing instruments such as bills, bonds etc.

So if interest goes up -> Sell IRFs position is profitable, which offsets the loss on long bond position and vice versa.

#13

but isn’t the definition of interest rate future : future with an interet bearing underlying?

definition of credit products : underlying=obligation with fixed credit spread?

where is the confusion ?

thx…am gonna get some food now… toodles.

#14

right, and that is what is happening in this question. but are your sure the underlying cannot in some instances be the rate? for example, a put can be written on a bond or an interest rate.

#15

bills, bonds are interest bearing instruments. what is the confusion?

#16

Because you can write a put on a bond or write a put on an interest rate.

If you write a put on the bond, you want rates to go up and bond value to go down.

If you write a put on the rate, you want rates to go down and bond value to go up.

So it’s two different positions taken.

#17

This also confused the shit outta me. When they say they are long the rate, i think rate goes up, they make money. I really think it needs to be explicitly stated what the underlying is, because there are definitely credit products out there that are literally bets on the rate with the rate as underlying.

I think this is the only case in the curriculum where it is unclear though, credit spread forwards and options are long the actual rate.

#18

yes, agree with you they would specify. they couldnt just say long put. they would have to say long interest rate put or long put on treasury bond.

have you seen interest rate futures that were long/short the rate? i guess thats possible?

#19

i was only talking about IRFs here and not Puts

#20

I don’t know if this is what you meant to say before but I found in CFAI Volume 4 Page 115: "Interest rate futures contracts are traded on short-term instruments (for example, treasury bills and eurodollars) and longer term instruments (for example, Treasury notes and bonds).

So the underlying is the bond.