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ACCA Applied Skills · Financial Management · Hedging techniques for interest rate risk

A company sells interest rate futures at 96.00 to hedge future borrowing. When the loan starts, the spot interest rate has risen by 1% and the futures price is 95.30. Which statement about the hedge is correct?

The hedge is imperfect because basis risk exists. The futures price fell only 0.70 while interest rates rose 1.00, so the gain on the short futures position does not fully offset the higher borrowing cost.

  1. AThe hedge is imperfect because the futures price fell by 0.70 while rates rose by 1.00, showing basis has changedCorrect
  2. BThe hedge is perfect because futures prices always move exactly with spot rates
  3. CThe company makes a loss on futures because the price fell
  4. DThe futures price should have risen because rates rose

Explanation

A fall of 0.70 against a 1.00 rate rise means futures gain less than the extra interest cost; basis has not converged proportionally, so the hedge is imperfect. The short position gains, not loses, when price falls. Futures prices fall when rates rise.

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