Question

Today, the gross price of a 10-year bond with $1,000 principal amount is 116.277. At the same moment, the price of the 10-year futures contract, which expires in two months, is 98.03. Its nominal amount is $100,000, and the deposit margin is $1,000. One month later, the price of the bond is 120.815 as the futures price is 102.24.

i) What is the leverage effect on this futures contract?

ii) An investor anticipates that rates will decrease in a short-term period. His cash at disposal is $100,000.

(a) What is the position he can take on the market using the bond? What is his absolute gain after one month? What is the return rate of his investment?

(b) Same question as the previous one using the futures contract.

(c) (1 mark) Conclude.

Answer 1

Answers:

1. The leverage effect of the futures contract is 100 Leverage Effect= Nominal Amount Deposit Margin =

100,000 1,000 =100

.

2. (a) The investor anticipates a decrease in rates so he will buy bonds. His cash at disposal is $100,000. Then he buys 86 bonds

Number of bonds bought= $100,000 $1,000×116.277% =86

His absolute gain over the period is $3,902.68

Absolute Gain=86×$1,000×[120.815−116.277]%=$3,902.68

The return rate of his investment over the period is 3.903% Return Rate= $3,902.68 $100,000 =3.903%

.
(b) Futures contracts move in the same way as bonds when interest rates change, so the investor will buy futures contracts.

His cash at disposal is $100,000, then he buys 102 futures contracts

Number of futures contracts bought= $100,000 deposit margin×futures price = $100,000 $1,000×98.03% =102

His absolute gain over the period is Absolute Gain=102×$100,000×[102.24−98.03]%=$429,420 The return rate of his investment over the period is 429.42%

Return Rate= $429,420 $100,000 =429.42%

.

(c) The difference of performance between the two investments is explained by the leverage effect of the futures contract.