8/24/2025
Chapter 6
Interest Rate Futures
Options, Futures, and Other Derivatives, 11th Edition, Copyright ©
John C. Hull 2021 1
Day Count Convention
Defines:
the period of time to which the interest rate applies
The period of time used to calculate accrued
interest (relevant when the instrument is bought of
sold
Options, Futures, and Other Derivatives, 11th Edition,
Copyright © John C. Hull 2021 2
Day Count Conventions
in the U.S.
Treasury Bonds: Actual/Actual (in period)
Corporate Bonds: 30/360
Money Market
Instruments: Actual/360
Options, Futures, and Other Derivatives, 11th Edition,
Copyright © John C. Hull 2021 3
1
8/24/2025
Examples
Bond: 8% Actual/ Actual in period.
4% is earned between coupon payment dates.
Accruals on an Actual basis. When coupons are
paid on March 1 and Sept 1, how much interest is
earned between March 1 and April 1?
Bond: 8% 30/360
Assumes 30 days per month and 360 days per
year. When coupons are paid on March 1 and
Sept 1, how much interest is earned between
March 1 and April 1?
Options, Futures, and Other Derivatives, 11th Edition,
Copyright © John C. Hull 2021 4
Examples continued
T-Bill: 8% Actual/360:
8% is earned in 360 days. Accrual calculated by
dividing the actual number of days in the period by
360. How much interest is earned between March
1 and April 1?
Options, Futures, and Other Derivatives, 11th Edition,
Copyright © John C. Hull 2021 5
The February Effect (Business Snapshot 6.1)
How many days of interest are earned
between February 28, 2021 and March 1,
2021 when
day count is Actual/Actual in period?
day count is 30/360?
Options, Futures, and Other Derivatives, 11th Edition,
Copyright © John C. Hull 2021 6
2
8/24/2025
Treasury Bill Prices in the US
360
P (100 Y )
n
Y is cash price per $100
P is quoted price
Options, Futures, and Other Derivatives, 11th Edition,
Copyright © John C. Hull 2021 7
Treasury Bond Price Quotes
in the U.S
Cash price = Quoted price + Accrued Interest
Options, Futures, and Other Derivatives, 11th Edition,
Copyright © John C. Hull 2021 8
Treasury Bond Futures
Cash price received by party with short
position =
Most recent settlement price × Conversion
factor + Accrued interest
Options, Futures, and Other Derivatives, 11th Edition,
Copyright © John C. Hull 2021 9
3
8/24/2025
Example
Most recent settlement price = 90.00
Conversion factor of bond delivered = 1.3800
Accrued interest on bond =3.00
Price received for bond is 1.3800×90.00+3.00
= $127.20 per $100 of principal
Options, Futures, and Other Derivatives, 11th Edition,
Copyright © John C. Hull 2021 10
Conversion Factor
The conversion factor for a bond is
approximately equal to the value of the bond
on the assumption that the yield curve is flat
at 6% with semiannual compounding
Options, Futures, and Other Derivatives, 11th Edition,
Copyright © John C. Hull 2021 11
CBOT T-Bonds & T-Notes
Factors that affect the futures price:
Delivery can be made any time during the
delivery month
Any of a range of eligible bonds can be delivered
The wild card play
Options, Futures, and Other Derivatives, 11th Edition,
Copyright © John C. Hull 2021 12
4
8/24/2025
Eurodollar Futures
Eurodollar futures are futures on the 3-month LIBOR
rate
One contract is on the rate earned on $1 million
A change of one basis point or 0.01 in a Eurodollar
futures quote corresponds to a contract price change
of $25
Options, Futures, and Other Derivatives, 11th Edition,
Copyright © John C. Hull 2021 13
Eurodollar Futures continued
A Eurodollar futures contract is settled in cash
When it expires the final settlement price is
100 minus 3-month LIBOR
The LIBOR rate is observed two days before
the third Wednesday of the month
Options, Futures, and Other Derivatives, 11th Edition,
Copyright © John C. Hull 2021 14
Eurodollar Futures Example
(Table 6.2)
Date Trade Settlement Change Gain per
Price futures price contract
May 21 99.720
May 21 99.715 -0.005 -12.50
May 22 99.665 -0.050 -125
……. …… …… …… ……
Sept 14 99.810 +0.010 +25
Total +0.090 +225
Options, Futures, and Other Derivatives, 11th Edition,
Copyright © John C. Hull 2021 15
5
8/24/2025
Hedging
The contract can be used for hedging in a
situation where a 3-month interest rate on $1
million, linked to LIBOR, is due to be received
for a 3-month period starting on Sept 14
What rate does the contract lock in?
Options, Futures, and Other Derivatives, 11th Edition,
Copyright © John C. Hull 2021 16
SOFR Futures
The one-month SOFR futures is designed to
be as similar as possible to the one-month
Fed Fund futures contract and is based on an
arithmetic average of overnight rates
The three-month SOFR futures is designed
to be as similar as possible to the three-
month Eurodollar futures and is based on the
result of compounding overnight rates
Options, Futures, and Other Derivatives, 11th Edition,
Copyright © John C. Hull 2021 17
3-Month Eurodollar Futures vs.
3-month SOFR Futures
The 3-month Eurodollar futures for a contract
month is settled on the third Wednesday of
the month and equal to the 3-month LIBOR
rate observed two days earlier
The 3-month SOFR futures for the same
contract month is settled 3-months later
(when all the relevant overnight rates have
been observed)
Options, Futures, and Other Derivatives, 11th Edition,
Copyright © John C. Hull 2021 18
6
8/24/2025
Using SOFR for Hedging (Example 6.3)
A company has agreed to pay three month
SOFR plus 200 basis points on $100 million
for three months starting on December 16,
2021
The December SOFR futures price is 99.990
What rate can the company lock in?
Options, Futures, and Other Derivatives, 11th Edition,
Copyright © John C. Hull 2021 19
Forward Rates
We can usually assume that forward prices equal
futures prices
For interest rate futures that last more than about
two years we cannot do this
Options, Futures, and Other Derivatives, 11th Edition,
Copyright © John C. Hull 2021 20
There are Two Reasons
Futures is settled daily whereas FRA is settled
once (true for both Eurodollar and SOFR)
Futures is settled at the beginning of the
underlying three-month period; FRA is settled at
the end of the underlying three- month period (true
for Eurodollar)
Options, Futures, and Other Derivatives, 11th Edition,
Copyright © John C. Hull 2021 21
7
8/24/2025
Convexity adjustment
Forward Rate = Futures Rate − c
where c is referred to as a convexity adjustment
Options, Futures, and Other Derivatives, 11th Edition,
Copyright © John C. Hull 2021 22
Extending Zero Curves
Forward rates can be used to bootstrap the
zero curve
Options, Futures, and Other Derivatives, 11th Edition,
Copyright © John C. Hull 2021 23
Example (equation 6.2)
R2T2 R1T1
F
T2 T1
so that
F (T2 T1 ) R1T1
R2
T2
If the 400-day zero rate has been calculated
as 4.80% and the forward rate for the period
between 400 and 491 days is 5.30 the 491
day rate is 4.893%
Options, Futures, and Other Derivatives, 11th Edition,
Copyright © John C. Hull 2021 24
8
8/24/2025
Duration Matching
This involves hedging against interest rate
risk by matching the durations of assets
and liabilities
It provides protection against small
parallel shifts in the zero curve
Options, Futures, and Other Derivatives, 11th Edition,
Copyright © John C. Hull 2021 25
Duration-Based Hedge Ratio
(equation 6.3)
PD P
VF DF
VF Contract price for interest rate futures
DF Duration of asset underlying futures at
maturity
P Value of portfolio being hedged
DP Duration of portfolio at hedge maturity
Options, Futures, and Other Derivatives, 11th Edition, Copyright
© John C. Hull 2021 26
Example
It is August. A fund manager has $10 million invested
in a portfolio of government bonds with a duration of
6.80 years and wants to hedge against interest rate
moves between August and December
The manager decides to use December T-bond
futures. The futures price is 93-02 or 93.0625 and the
duration of the cheapest to deliver bond will be 9.2
years at the futures contract maturity
The number of contracts that should be shorted is
10,000,000 6.80
79
93,062.50 9.20
Options, Futures, and Other Derivatives, 11th Edition,
Copyright © John C. Hull 2021 27
9
8/24/2025
Limitations of Duration-Based
Hedging
Assumes that only parallel shift in yield curve
take place
Assumes that yield curve changes are small
When T-Bond futures is used assumes there
will be no change in the cheapest-to-deliver
bond
Options, Futures, and Other Derivatives, 11th Edition,
Copyright © John C. Hull 2021 28
GAP Management (Business Snapshot 6.3)
This is a more sophisticated approach used
by banks to hedge interest rate. It involves
Bucketing the zero curve
Hedging exposure to situation where rates
corresponding to one bucket change and all other
rates stay the same
Options, Futures, and Other Derivatives, 11th Edition,
Copyright © John C. Hull 2021 29
Liquidity Risk
If a bank funds long term assets with short
term liabilities such as commercial paper, it
can use FRAs, futures, and swaps to hedge
its interest rate exposure
But it still has a liquidity exposure.
It may find it impossible to roll over the
commercial paper if the market loses
confidence in the bank
Northern Rock is an example of this type of
liquidity problem
Options, Futures, and Other Derivatives, 11th Edition,
Copyright © John C. Hull 2021 30
10