Financial Management · Hedging techniques for interest rate risk

Interest Rate Futures Hedging for ACCA FM

Updated 11 October 2026 · Fact-checked

Interest rate futures are standardised contracts priced at 100 minus the interest rate. To hedge borrowing, you sell futures now and buy them back when the rate is fixed. Gains on the futures offset higher interest. Work out the number of contracts, tick value and basis, then compare the futures result with the cash interest.

Understand Interest Rate Futures

An interest rate future is a standardised, exchange-traded contract on a notional short-term deposit, for example a three-month deposit of $1,000,000. Its price is quoted as 100 minus the annual interest rate. A price of 95.00 means an interest rate of 5.00%. When rates rise, the futures price falls. When rates fall, the price rises.

This price link tells you which side to take. A borrower fears rising rates. Rising rates push the price down, so the borrower sells futures now. If rates rise, the borrower buys the futures back cheaper and makes a gain. That gain offsets the extra interest on the loan. A lender or depositor fears falling rates, so they buy futures.

You do not usually deliver anything. You close out by doing the opposite deal on the date the rate is fixed. The profit or loss is settled in cash. Because the contract is standard, you must match your exposure to it. Contract size and period are fixed, so you work out the number of contracts, and you pick the contract month. For borrowing, choose the contract that expires on or after the date the loan starts.

The smallest price move is a tick, usually 0.01% (0.0001, or one basis point). Tick value = contract size × 0.01% × contract months ÷ 12. For a $1,000,000 three-month contract this is $25.

Basis is the futures price minus the spot (cash) price, where spot price = 100 minus the current spot rate. Basis shrinks to zero at expiry. If you close out before expiry, some basis remains. ACCA usually asks you to assume it falls in a straight line over the months left. Futures give a margin-based, standardised hedge. An FRA is a tailor-made over-the-counter contract with a bank. FRAs fix a rate for the exact amount and dates. Futures can be traded out at any time but may not fit exactly, which leaves some residual risk.

Key rules to remember

Futures price: Futures price = 100 − annual interest rate (%); A price of 94.50 implies a rate of 5.50%. Price down means rates up.
Tick value: Tick value = contract size × 0.01% × (contract months ÷ 12); For $1,000,000 and 3 months: 1,000,000 × 0.0001 × 3/12 = $25. Use the contract size given in the question.
Number of contracts: Contracts = (loan or deposit ÷ contract size) × (loan months ÷ contract months); Round to the nearest whole contract. A 6-month loan on a 3-month contract doubles the number.
Which side to take: Borrower: sell futures. Lender or depositor: buy futures.; Close out by doing the opposite deal on the date the rate is fixed.
Futures gain or loss: Gain or loss = price movement in ticks × tick value × number of contracts; Borrower sold at a higher price than the closing price makes a gain.
Basis: Basis = futures price − spot price, where spot price = 100 − spot rate; It falls to zero at expiry.
Basis at close-out: Basis at close-out = current basis × (months left to expiry ÷ months from today to expiry); This is a straight-line estimate. Use it to find the expected futures price on the closing date.
Effective interest rate: Net interest cost = cash interest − futures gain (or + futures loss); effective rate = net cost ÷ loan × 12 ÷ loan months; Always compute it as a check on the answer.

How to solve Interest Rate Futures questions

Use the same sequence for every futures hedge question. Write each step down, because marks are given for method.

1Identify the exposure: borrowing or deposit, amount, start date and length. Decide the direction of risk. A borrower fears a rate rise, so sells futures. A depositor fears a rate fall, so buys.
2Choose the contract month: the first one that expires on or after the date the rate is fixed (when the loan starts).
3Calculate the number of contracts using the loan size, contract size and the loan period against the contract period. Round to a whole number.
4Calculate the tick value from contract size and contract period, unless the question gives it.
5Find the opening futures price. If basis applies, estimate the futures price at close-out from the spot rate then, adjusted for the remaining basis. Otherwise assume futures equal spot.
6Work out the futures gain or loss in ticks × tick value × contracts. Check the sign: a borrower who sold high and bought back low gains.
7Calculate the cash interest paid at the new rate, then net it with the futures result. State the net cost and the effective annual rate.
8Comment briefly if asked: the hedge is not perfect because of basis, rounding of contracts and the fixed contract size.

Quickest way: Rate-move shortcut

When to use it: Use when the question asks for the net interest cost or effective rate and the contract size and period are easy to match to the loan.

Convert the opening futures price to the locked-in rate: 100 − price. With no basis this is the effective rate.
Check the contracts: if the loan amount and period match the contracts exactly, the hedge fixes the rate at that level.
Still compute the gain in full for the working: ticks × tick value × contracts, so you earn method marks.
Cross-check: closing cash rate − futures movement (in %) = effective rate. For a borrower, this should match net cost ÷ loan × 12 ÷ months.
If basis exists, only the movement in futures prices counts, so first estimate the closing futures price before using this shortcut.

Common mistakes in Interest Rate Futures

Buying futures when you should sell, or the reverse.
Students think in terms of the interest rate rather than the price. Price moves the opposite way to the rate.
Fix: Write: rates up means price down. A borrower wants a gain when rates rise, so must sell first and buy back lower.
Forgetting the loan period when working out the number of contracts.
Students divide the loan by the contract size and stop. The contract covers only three months.
Fix: Multiply by loan months ÷ contract months. A 6-month loan on a 3-month contract needs twice as many contracts.
Using the wrong tick value, for example $100 instead of $25.
Students ignore the time factor and use size × 0.01% only.
Fix: Always include contract months ÷ 12. Recalculate: 1,000,000 × 0.0001 × 3/12 = $25.
Treating basis as constant, or ignoring it altogether.
Students assume the futures price equals the spot price at close-out.
Fix: Basis falls to zero at expiry. Estimate it as basis × months left ÷ months from today to expiry, and use it to find the closing futures price.
Choosing a contract that expires before the loan starts.
Students pick the nearest contract month without checking dates.
Fix: Pick the first contract expiring on or after the date the rate is fixed, so the hedge is still open when you need it.
Stating the answer as if the hedge were perfect, and forgetting to net the futures result against the interest.
Students stop after calculating the gain or loss on the futures.
Fix: Compute the cash interest, add or deduct the futures result, and give the net cost and effective rate. Mention residual risk from basis and rounding.

Worked examples

Example 1

On 1 March a company expects to borrow $6,000,000 on 1 June for six months. The borrowing rate floats and is currently 4.2%. The June three-month futures contract (size $1,000,000, tick size 0.01%) is priced at 95.80 on 1 March. Assume the June contract expires on 1 June, so there is no basis. On 1 June the borrowing rate is 5.5% and the futures price is 94.50. Calculate the net interest cost and the effective annual rate using futures.

Show the solution

Direction: the company is a borrower and fears a rate rise, so it sells June futures on 1 March at 95.80.
Contracts: 6,000,000 ÷ 1,000,000 = 6, multiplied by 6 months ÷ 3 months = 12 contracts sold.
Tick value: 1,000,000 × 0.0001 × 3/12 = $25.
Close out on 1 June: buy back at 94.50. Price movement = 95.80 − 94.50 = 1.30 = 130 ticks.
Futures gain = 130 × $25 × 12 = $39,000.
Cash interest at 5.5%: 6,000,000 × 5.5% × 6/12 = $165,000.
Net interest cost = 165,000 − 39,000 = $126,000.
Effective rate = 126,000 ÷ 6,000,000 × 12/6 = 4.2%, which equals 100 − 95.80.

Answer: The company sells 12 June contracts, gains $39,000 on the futures, and has a net interest cost of $126,000, an effective rate of 4.2% a year.

Example 2

On 1 April a company plans to borrow $9,000,000 on 1 July for three months. On 1 April the spot three-month rate is 3.5% and the September three-month futures contract (size $1,000,000, tick 0.01%, expiry 30 September) is priced at 96.10. On 1 July the spot rate is 5.0%. Assume basis reduces in a straight line to expiry. Calculate the futures price on 1 July, the futures gain and the effective annual rate.

Show the solution

Direction: borrower, so sell September futures at 96.10.
Contracts: 9,000,000 ÷ 1,000,000 = 9, multiplied by 3 ÷ 3 = 9 contracts. Tick value = $25.
Opening basis: spot price = 100 − 3.5 = 96.50. Basis = 96.10 − 96.50 = −0.40.
Time: from 1 April to 30 September is 6 months. On 1 July there are 3 months left, so basis then = −0.40 × 3/6 = −0.20.
Spot price on 1 July = 100 − 5.0 = 95.00. Futures price on 1 July = 95.00 − 0.20 = 94.80.
Gain: 96.10 − 94.80 = 1.30 = 130 ticks. Futures gain = 130 × $25 × 9 = $29,250.
Cash interest: 9,000,000 × 5.0% × 3/12 = $112,500. Net cost = 112,500 − 29,250 = $83,250.
Effective annual rate = 83,250 ÷ 9,000,000 × 12/3 = 3.7%. Check: 5.0% − 1.30% = 3.7%.

Answer: The expected futures price on 1 July is 94.80. The gain is $29,250, the net interest cost is $83,250, and the effective rate is 3.7% a year. This is a little different from the 3.9% implied by the opening futures price because the hedge is not perfect.

Exam tips

Write the rule 'price = 100 − rate' at the top of your answer. It tells you which side to take and stops the most common error.
Check the contract size, period and tick size in the question. ACCA may give a different size, such as £500,000, so recalculate the tick value rather than using $25 from memory.
In a Section C answer, show the layout: contracts, tick value, closing futures price, futures gain, cash interest, net cost and effective rate. Each is a mark.
For objective questions, look for tricks such as the period multiplier for contracts or the remaining-basis fraction. Calculate on paper and check against the four options.
If asked to compare with an FRA or option, say that futures are standardised and exchange-traded with margins and basis risk, while an FRA is tailor-made and over the counter. Options protect against adverse moves but cost a premium.

Practice questions from Hedging techniques for interest rate risk

Interest Rate Futures in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Interest Rate Futures: frequently asked questions

What is the difference between an FRA and interest rate futures?

An FRA is an over-the-counter agreement with a bank that fixes a rate for an exact amount and period, so the hedge can match the exposure. Futures are standardised, exchange-traded and need margin. They can be closed out at any time but come with fixed sizes and dates, so there is basis risk and some mismatch.

Does a borrower buy or sell interest rate futures?

A borrower sells futures to hedge against a rate rise. Rates up means the futures price falls, so the borrower buys the contracts back at a lower price and gains. A lender or depositor buys futures to hedge against a rate fall.

What is the tick size and tick value in an interest rate futures question?

The tick size is the smallest price move, usually 0.01%. Tick value = contract size × 0.01% × contract months ÷ 12. For $1,000,000 and three months it is $25. Use the contract size stated in the question.

What is basis in interest rate futures?

Basis is the futures price minus the spot price, where spot price is 100 minus the spot rate. It shrinks to zero at expiry. In exam questions you usually assume it falls in a straight line, so basis left on the closing date is the opening basis × months remaining ÷ months from the start.

Why is the hedge using futures not perfect?

Contract sizes are fixed, so the number of contracts has to be rounded. Basis may not narrow as assumed. The contract dates may not match the loan dates, and the futures price may not move in step with your actual borrowing rate.