Stock Index Futures Arbitrage

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1. Stock Index Futures Arbitrage 1. Should Peoples Federal Savings have hedged its September 1 savings certificate rollover? Yes, it should have made the hedge! Reasons: 1. Certainty about the interest payment. The key aspect of a hedge is that the payment is fixed but it cannot be said that the result would be better with a hedging strategy. In the current situation, the company receives fixed interest payment and pays variable interest payments. In the case of rising interest rates the company is exposed to a considerable risk. Therefore a short hedge is necessary. This strategy offsets any possible loss of rising interest rates by gains in the futures position. Due to the fact, that the certificates were priced at a fixed spread over T-bills the T-Bill future represents the appropriate hedge instrument. Another argument in favour of hedging is that the company is able to focus on their core business instead of focusing on the market movements of the underlying asset. In our case the interest rate plunged and the future was not favourable. On the contrary, if the interest rate had increased, the upside risk would have been limited. 2. Uncertainty and protection The first mortgage loans generate interest earnings which are not much affected by interest rate fluctuations. These loans were financed by consumer deposits, which consist largely of 3 month fixed rate savings certificates. Due to the short duration and the increasing interest rates in the past, the deposits are highly sensitive the interest rate changes. Therefore, the mismatch between interest payable and interest receivable had to be solved. As showed in the table below the interest rates as well as the nominal value diverge from another. | |(1982) |1981 |1980 |1979 | |FML

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