Question

How are HSI HIBOR and HSI futures related? Need data or figure. thanks

Answer 1

1. The Hang Seng Index (HSI) is a market capitalization-weighted index of the largest companies that trade on the Hong Kong Exchange consisting of 33 Blue chip stocks. It has four sub-indicies: Finance, Utilities, Properties and Commerce & Industry. The index was first published in 1969 (the base date). The index and sub-indicies are calculated using the weighted market capitalisation method i.e.,

(Currnt Total market Value of Constituent Stocks / Total Market value of Constituent stocks at base date) x 100

Because the index is based on a weighted average of market value, and market value is determined by the price of the stock multiplied by the number of shares outstanding, the impact on the index of a price change in any given stock will depend on the size of that company's market capitalisations.Share companies with higher market capitalisation have greater impact on the index than those with lower market capitalisation.

Hang Seng Index Futures

• Buying or Selling HSI Futures contracts alllows to participate in the overall price movement of the Hong Kong stock market, i.e., the 33 stocks in the index.
• The value of each HSI Futures is calculated as: Value of HSI Future = $50 x (level of index)   For example, if the current level of the futures index is at 10,000, then the contract value is $500,000.
• The HSI Futures are traded in Futures Exchange of Hong Kong for future delivery, and rae settled in cash for the difference of the contracted index value and the spot index value.
• Delivery months are the current (spot) month, the next calender month, and the next two calender quarter months. Margin deposits are required for all participants (both buyers and sellers)

Hang Seng Index Futures

The HSI Options are European Options.

Example: Bella wants to buy an HSI put option which expires in June and has a strike price of 10,000 index points. If the market declines to 9,000 on the expiry day, she can exercise the option or settle the difference in cash between the strike price and the official settlement price (which is the average of the quotations of the HSI taken at five minute intervals during the expiry day and is very close to the HSI), provided that the strike price (which is 10,000) is higher than the current market level (or the official settlement price) of 9,000. For this transaction, her profit for one contract is $50 x 1,000 points or $50,000 minus the premium she paid. It makes no sense to exercise if the strike price is lower than the official settlement price because her position is out-of-the-money.

Assuming a situation where she expects that market will fall substantially in near future and wants to hedge her stock portfolio. For that there are two different strategies: (1) she can sell HSI Futures and (2) she can buy HSI put options and assume that market declines by 10% from the 10,000 point level to the 9,000 point level and there is no transaction cost.

Strategy 1:

She sells 20 HSI futures contracts of June delivery with total contract value of $10.0 million

$50 per index point x 10,000 points x 20 contracts = $10.0 million

If the market declines to the 9,000 point level, she can buy back 20 contracts of June delivery at 9,000 to close out the original position, and gain $1.0 million.

$50 per index point x 20 contracts x (10,000 - 9,000) = $1.0million

At the 9,000 index level, your stock portfolio is worth only $9.0 million. With the 41.0 million gain, total investment value remains at $10.0 million. (she will have to pay a small amount of margin depposit. However, she will get it back when she closes her account).

Strategy 2:

Buy 20 June put option contracts at a strike price of 10,000 HSI points (an at-the-money option because at the time she buys these contracts, the market is at 10,000).Assuming that the premium is 300 points.

$50 per point x 20 contracts x (10,000 - 9,000) - $50 x 20 x 300 premium points = $700,000

Because of option premium, she could only recover the partial amount of the loss by using option. That is why she should have listen to financial treasurers that using options to hedge is very expensive.

The main advantage of using options in this situation is allowing yourself to benefit from upside potential. If one's expectation is wrong and the index surges, he/ she will gain from those stocks while a loss will cost an option fee of $300,000.

HIBOR

The Hong Kong Interbank Offered Rate (HIBOR), is the benchmark interest rate, stated in Hong Kong dollars, for lending between banks within the Hong Kong market. The HIBOR is a reference rate for lenders and borrowers that participate directly or indirectly in the Asian economy.

In Hong Kong, the 3-months HIBOR futures were introduced by Hong Kong Futures Echange in 1990 provide banks, corporate treasures and investors with an important vehicle for hedging and speculting on interest rates.

Like others, HIBOR futures also operate by providing a standardised contract basis for trading commodities and financial instruments for future delivery on marging deposits. The contract size is HK$1.0 million with future delivery in the months of March, June, September, December for up to two years.

Each basis point is worth$25, and the contracts are settled in cash. The Exchange Delivery settlemnt price(EDSP) is used to determine the settlemnt price, The EDSP is derived from quotations for 3-months interbank offered rates randomly selected from 12 participating banks. The highest and the lowest two are discarded and the remaining eight averaged to an arithmetic mean.

HIBOR Futures are quoted at 100 minus the implied futures rate. For example, assuming that the HIBOR rates are at 6.0 percent (the spot rate) and the June 3-months futures rate is 6.25 percent(recall the pricing relation between spot and futures rates), the June 3-months HIBOR Future prices should be quoted at 93.75 (100-6.25).

Assume Christian is a corporate treasurer and plans to borrow $100.0 million in June for three months, and he thinks that the rates will move up in the near future, increasing his borrowing cost. So, he can hedge this potential interest rate risk exposure using HIBOR futures:

He sells HIBOR futures at the Current price of 93.75.

If his prediction is right and 3-month HIBOR moves up to 7.25% in June and EDSP for the June contract is 92.75 (100-7.25), he can close out his short sale position by buying 100 futures contracts at 92.75 and have a gain of $250,000:

(93.75 - 92.75) x 100 (basis point) x $25 per basis point x 100 contracts = $250,000.

The gain of $250,000 will be offset by the increase of borrowing cost of one percent for three months.

Although HIBOR Futures can be used as a hedging vehicle, they are trading very inactively. similar to HSI Futures participants are required to put up margins - both initial margin and maintainance margin. Margin requirement for HIBOR participants are usually minimal and are returned on the close-out.

In addition to HSI Futures , HSI Options and HIBOR Futures, there are also warrants, single stock options and futures traded in Hong Kong. However, they are more company specific and are less useful for hedging a portfolio.