1. Phobos Interest Rate Hedging Mark Fielding-Pritchard mefielding.com1

2. Phobos  Wants to borrow money, £30m  Loan taken out 1 March, for 4 months  Sell  March  (30m/0.5)x (4/3)= 80  On 1 January sell 80 March’s @ 93.88  On 1March buy back  Note. On 1 January Libor is 6%, therefore the price of a future should be 94. But it isn’t, it is 93.88, therefore we have basis risk of 0.12% (12 ticks) mefielding.com2

3. Phobos You need to calculate the decline in basis risk to get the value of the future on close out Basis risk1 Jan 12 basis points Basis risk1 Mar 4 basis points mefielding.com3

4. Phobos  So basis risk will be 3 basis points from LIBOR at 1 March for a March future  Implied interest is greater than LIBOR so future price will be below expected LIBORFuture Price 7%92.96 5%94.96 mefielding.com4

5. Phobos mefielding.com5 LIBOR5% 7% (Additional)/ Saved Interest 100000(100000) FutureSold 93.88 Buy 94.96 Loss 108 Sold 93.88 Buy 92.96 Gain 92 Gain/ Loss1.08% x £500000 x 3/12 x 80 (108 ticks x 12.50 x 80= 108000) 0.92% x £500000 x 3/12 x 80 (92 ticks x 12.50 x 80= 92000) Hedge Efficiency100000/108000= 92.6%92000/100000= 92%

6. Phobos- Options  Options are just options to buy or sell futures  With futures we sold 80 March so here we want 80 March puts  Which exercise price? And what is the premium cost? mefielding.com6 StrikeInterestPremium 937506250456.295 9400060001686.168 9425057503006.050 Therefore we buy on 1/1 80 March puts, premium cost 0.3% x 500000 x 3/12 x 80 = £30000 (30 x 12.5 x 80= £30000)

7. Phobos mefielding.com7 LIBOR5% 7% (Additional)/ Saved Interest 100000(100000) FutureSold 94.25 Buy 94.96 Don’t exercise Sold 94.25 Buy 92.96 Gain 129 Gain/ LossPremium £300001.29% x £500000 x 3/12 x 80= 128000 (129 ticks x 12.50 x 80= 129000)

8. Phobos mefielding.com8 LIBOR5% 7% (Additional)/ Saved Interest 100000(100000) FutureGain of £100000 becomes net loss of £8000 Loss of £100000 reduced by gain of £92000 OptionGain of £100000 reduced by premium of £30000 Loss of £100000 becomes loss of £1000

9. Phobos  Potentially interest rates can rise and rise, UK 22%  Selling puts is risk without limits  Our numbers don’t include costs  SWAPS can build in risk for years  Basis risk means there are under/over hedged liabilities  Derivatives should not be used for speculating mefielding.com9