Hedging Floating Margin Costs with Interest Rate Futures

Summary

The document considers how to hedge a borrowing cost that floats with the federal funds rate plus a lender margin, when swaps are unavailable. It discusses short positions in two-year Treasury futures and federal funds futures, and suggests Eurodollar futures as another instrument. These contracts offer ways to take exposure to changes in short-term rates, but they differ in maturity, liquidity, and how closely their prices track the borrower’s actual funding rate.

The responses describe Treasury futures as liquid and potentially suitable when the hedge horizon is around two years, while federal funds futures can be matched more closely to the liability and allow the hedge maturity to vary. Treasury yields may diverge from the federal funds curve, creating basis risk. The question also raises collateral funding and futures roll costs. The discussion is brief and does not calculate hedge ratios or compare total costs; its Eurodollar suggestion relies on LIBOR’s relationship to federal funds and does not assess that basis risk.

Key ideas

• Interest rate futures can hedge exposure to a floating borrowing rate when swaps are inaccessible.
• Two-year Treasury futures may offer liquidity but can diverge from federal funds rates.
• Federal funds futures can align more directly with the liability and offer flexible maturities.
• Collateral funding and rolling futures can add costs to a hedge.
• Eurodollar futures are suggested as a longer-dated alternative, with rate basis risk left unquantified.

Tags

# Best way to lock in margin rate via hedging


# Best way to lock in margin rate via hedging












I'm currently paying a 1.25% margin rate. This rate is based on the Fed Funds rate plus a margin. I would like to hedge against the possibility of this margin rate increasing. What is the best/cheapest way to do that? I have access to the futures market but not the market for swaps.

Some hedging ideas:

- Short 2-year Treasury futures. Roll the futures every quarter and eat the cost of rolling since treasury futures are in backwardation. Also, I have to pay margin costs on the $2000 I borrow to put up as collateral for every contract I short.

- Short Fed Fund futures. However, these don't go out very far. Also, I still have to pay margin costs on the money I borrow for collateral.

Any other ideas? Pros/cons/costs of the above?

## Answer by dm63 (score 0)

https://quant.stackexchange.com/a/61176

Those are both reasonable ideas. The pros of the Treasury futures : a) very liquid b) works well assuming you are pretty certain you will pay margin for a 2yr timeframe. The pros of the Fed funds futures : a) you can vary your hedge maturity depending on the timeframe you anticipate b) they precisely hedge your liability , whereas 2yr Treasury doesn’t have to reflect Fed funds exactly (price can be at least a +/- 10bp spread to the equivalent strip of Fed Funds futures).

## Answer by Jay C (score 0)

https://quant.stackexchange.com/a/66080

You can go short eurodollar futures. The contact months go out for years and is tied to LIBOR rates, which are tied to fed funds

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.