hedging a interest rate rise

[jules]

How does one go about hedging a interest rate rise using derivatives/futures?

If the interest on a loan is currently variable (say 1% above base rate) is it possible to effectively fix this rate over the duration of the loan (20 years) by locking the rate using derivatives/futures to offset any rise in the variable rate?

many thanks

 

[bhargav]

Enter into swap contract which would convert floating rate liabilities of the loan into fixed rate liabilities.

Transactions on any interest payment date would be as follows:

Loan: Pay floating rate
Swap: Pay fixed and receive floating

 

[brianscott]

I believe one option if you only care about the upside risk would be to just buy an interest rate cap.

 

[jules]

I believe one option if you only care about the upside risk would be to just buy an interest rate cap.

thanks, where could one enter into this kind of contract?

 

[jules]

Enter into swap contract which would convert floating rate liabilities of the loan into fixed rate liabilities.

Transactions on any interest payment date would be as follows:

Loan: Pay floating rate
Swap: Pay fixed and receive floating

thanks, i will investigate this further.

 

[doug reich]

thanks, where could one enter into this kind of contract?

Different investment banks make markets in these OTC contracts; you would talk to your broker, who would know. They probably wouldn't work with an individual; they trade in large notional amounts.

 

[jules]

Enter into swap contract which would convert floating rate liabilities of the loan into fixed rate liabilities.

Transactions on any interest payment date would be as follows:

Loan: Pay floating rate
Swap: Pay fixed and receive floating

where could this be transacted for a retail customer? which brokers could be used? thanks

 

[bhargav]

As Doug pointed out, notional of swap contracts is very large. I guess you will have to get in touch with brokers of Investment banks, they might ask for huge margin. Why don't you look for "Services for Individual/retail investors" section in Ibank websites. I am sure you will come across contact email or phone

where could this be transacted for a retail customer? which brokers could be used? thanks

 

[doug reich]

If anybody will execute those trades, it is a full service broker, e.g. at an investment bank.

 

[bob]

The most convenient IR derivatives are only available OTC--swaps, caps/floors, and swaptions.

CME trades a large number of IR-related futures contracts. Eurodollar and Fed Funds are the best known (and undoubtedly the most liquid), but they trade others. You might be able to cobble some sort of strategy together there, but proceed with care.

Even if you find something that's theoretically sound (which may not be possible), the whole point of the hedge is to match cash flows, not just values. So even if you manage to create something with zero basis risk, the hedge may require a lot of spare cash to carry out, and lots of cheap access to the markets in question.

 

[jules]

thanks. i can trade eurodollar and fedfunds futures via my us broker, tradestation....but have no idea how i cobble a strat together via trading these instruments to acheive what im after?? Any pointers on this much appreciated.

 

[jules]

after some research, the swap idea is out as the banks are not interested due to size and individual circumstances.

so i'm still looking to get a hedge in place, but need to create something with futures/options. it has been suggested a few time that ir caplets would do the job.

does anyone here have any specific methods/tips on how one might go about this??