JOHANNESBURG STOCK EXCHANGEInterest Rates

The Short Dated Interest Rate Market – Trading JIBAR Futures

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The 3 Month JIBAR Rate

The Johannesburg Interbank Agreed Rate (JIBAR) isan average rate that is independently derived fromquotes obtained from a number of different banks forone, three, six and twelve month deposits.

In particular, the 3-month JIBAR rate is used as abenchmark, and is considered to be an indication ofthe mark to market yield on 3-Month NegotiableCertificates of Deposit (NCD's).

Figure 1 illustrates the volatility of the 3-Month JIBARrate over the past decade with the Monetary PolicyCommittee (MPC) dates represented as points onthe graph.

The JIBAR future represents an opportunity forhedgers looking to manage the interest rate riskassociated with this volatility as well as for marketparticipants wishing to exploit this volatility.

Figure 1: 3 Month JIBAR rates from 1 Jan 2000 to 31 Dec 2009

Pricing patterns in the JIBAR futures are very much areflection or mirror of conditions prevailing in themoney markets moving outwards on the yield curve.The JIBAR futures are based on a R100,000 facevalue, 3-month maturity JIBAR rate and are quotedas an interest rate. The price of a Jibar futurescontract is 100 minus the rate. The contractspecifications are given in the following table:

Defining the JIBAR Future

JIBAR Futures are Short Term Interest Rate (STIR) Futures based on the 3-month JIBAR (Johannesburg Interbank

Agreed Rate) rate. They are listed and traded on the Johannesburg Stock Exchange (JSE). Trading is conducted on

the JSE's Nutron platform where bids and offers can be placed on an electronic trading system. The aim of this

document is to illustrate (by way of examples) how to use JIBAR futures to achieve various outcomes.

Contract specifications

Contract Base 3-month JIBAR rate

Contract Notional ZAR 100,000 face value

Quotation Style The effective interest rate per contract

Contract Months March, June, September, December. In addition at all times there arefour near-term contracts listed such that there are always six consecutivenear months listed.

Basis point value ZAR 2.50 per basis point per contract

Settlement Cash

Settlement Yield 3-month JIBAR rate at expiry

Minimum Tick Size 0.001% (1/10 of a basis point)

141312

11

10

9

8

7

604/01/2000 30/09/2002 26/06/2005 22/03/2008 17/12/2010

MCP Dates3-Month JIBAR Rate

Rate

Table 2 illustrates what the trader's P&L's could looklike as a result of his transaction.

A Corporate Treasurer has borrowed R10 million forthree months, due to be rolled-over on Wednesday17 March 20xx (assume that this is the thirdWednesday of March 20xx). It is now February 20xx,and the Corporate Treasurer is worried that interestrates will rise (by more that the market expects)between now and March.

Rather than just waiting until the next rollover datethe Treasurer decides to hedge the exposure. TheMarch JIBAR Futures contract references the valueof the 3-month JIBAR rate on the third Wednesday ofMarch 20xx, which, in this case, happens to matchthe Treasurer's rollover date perfectly.

The Use of Leverage

Note that the trader in this example makes a gain of8.4bp (7.164% - 7.080%) which translates into aprofit of R210 (10 contracts x R2.50 x 8.4bp). This isachieved by taking exposure to a R1m investment byallocating margin of R1,000 (R100/contract x 10contracts). This shows the gearing or leverage that isinherent in the futures market. In contrast, a traderwould have to invest a full R1m in NegotiableCertificates of Deposit (NCD's) to achieve a similaroutcome.

Conversely, if the trader believes that short datedinterest rates will increase (or rates will turn out to behigher than what the market currently expects), thetrader can look to profit from this view by shortingJIBAR futures contracts.

Example 2: Hedging a JIBAR-Linked Loan(The Simple Hedge)

For all the following examples, we assume that it is

currently February 20xx and that the rates for

quarterly JIBAR Futures contracts are as follows:

Table 1: Strip of JIBAR Futures Prices

Table 1 shows a normal positively sloped yieldcurve, with the long rates higher than the short rates.These rates are indicative of the expected level of3-month JIBAR rates going out over the term. If atrader's view of the market does not agree with therates implied by the market (or if the trader faceslosses from interest rates moving in an adversedirection), the trader can attempt to profit from thisview by taking a position in JIBAR futures.

The behaviour of the trader can thus bedefined as follows:

Trader expects interest rates to fall (or tradebelow the market’s expectation of future rates):

Trader expects interest rates to rise (or tradeabove the market’s expectation of future rates):

A trader believes that short dated interest rates willdecline (or rates will turn out lower than what themarket currently expects).In order to profit from theanticipated movement in rates, the trader decides tobuy 10 March 'xx JIBAR futures contracts at a yield of7.164%.

Go Long (Buy a JIBAR future)

Go Short (Sell a JIBAR future)

Example 1: How to profit from declininginterest rates

Day DescriptionNumber ofContracts

Yield % MTMPosition

YieldChange

InitialMargin

VariationMargin

CashFlow P&L

0 7.164%

1 Trader buys 10 contracts 10 7.164% 7.10% -0.064% -1 000 160(10x2.5x6.4)

-840 160

2 7.12% 0.02% -50-(10x2.5x2)

-50 110

3 7.09% -0.03% 75(10x2.5x3)

75 185

4 Trader sells 10 contracts -10 7.08% 7.08% -0.01% 1,000 25(10x2.5x1)

1 025 210

Mar 'xx Jun 'xx Sep 'xx Dec 'xx

7.164% 7.500% 7.550% 7.800%

Table 2: Trader's Variation Margin

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Strip Hedges and Stack Hedges

Example 3: Trading the Shape of the yieldCurve using Calendar Spreads

A is where a trader uses a number ofdifferent contract months to hedge a position.

A trader can, for example, use 4 consecutive quarterlycontracts (March, June, September and December) tohedge a one year rate. This is called a “Strip Hedge”because the trader is using a “strip” of futures prices toreplicate a one-year rate.

A is where a trader uses just one futurescontract month to hedge a position that in order tocover the period concerned, would normally require aconsecutive series of futures contract months to bebought or sold.

For example, a trader can use only the March futurescontract to hedge a one year rate. This is called a“Stack Hedge” because the trader is effectivelystacking up all of the position into one contract monthonly. However, the trader would need to roll theposition as it approached its expiration and thus isexposed to rollover risk.

A trader may employ this type of strategy for variousreasons (e.g. there may be a lack of liquidity in the fardated contracts) but should bear in mind that by doingthis, the trader is effectively hedging one section of theyield curve with a different section, i.e. there isexposure to a change in the slope of the yield curve.

It is also possible for traders to trade one contractmonth against another, this is referred to as: trading“calendar spreads”. A calendar spread is generallyconsidered to be less risky than taking an outrightdirectional position in any one of the contracts.

If the current zero curve is positive (i.e. short terminterest rates are lower than long term interest rates),then this will be reflected in the current JIBAR Futurescurve, implying that near term futures prices will belower than subsequent contract months (as shown inTable 1).

A Trader might expect near term rates to remain static,but longer-term rates to rise more than implied by thefutures rates. The trader can simulate this trade in thefutures market, by buying 100 near date contracts(March at 7.164) and selling 100 far date contracts(Dec at 7.8), at a differential of +63.6 bp.

“Strip Hedge”

“Stack Hedge”

The Treasurer thus decides to sell 100 JIBAR Futurescontracts (R10m divided by R 100,000 per contract) at7.164%.

Assume that on the expiration of the March Futurescontract (17 March 20xx) the interest rates have risen(as expected) and the expiration level of the Futurescontract is 7.5%. The Treasurer would make a profit onhis Futures position as follows:

Profit on Futures = Number of contracts x change infutures yield (basis points) x basis point value= 100 x (7.5% – 7.164%) x R2.5/bp= 100 x 33.6 bp x 2.5= R 8,400.

This profit offsets the extra borrowing cost on theJIBAR linked loan that the Treasurer incurs on 17March 20xx (as a result of rising interest rates).

Extra borrowing cost = Actual borrowing cost lessexpected borrowing cost= [R 10m x (0.075 x (90/365))] – [R 10m x

(0.07164 x (90/365))]= R 184,391.51 – R 176,646.58= R 8, 284.93.

The profit that the Treasurer makes on the hedgeis thus: R 8,400 – R 8, 284.93 = R 115.07.

This is much smaller than the R 8,284.93 loss that theTreasurer would have incurred without the hedge. Thesmall profit that is made on the hedge is a result of the(Actual/365) day-count convention of the South AfricanMoney Market differing from the “1/4 of a year” natureof the Futures market, combined with the difference inconvexity between the loan and the hedge.

The JIBAR future has a fixed Rand per point valuewhile a loan has a varying Rand per point valuedependent on the prevailing interest rate. Hence amovement of one basis point in the loan position doesnot correspond to a movement of one basis point in thehedge – a more accurate hedge must incorporate thisdifference. This is done by the use of a Hedge Ratio asshown below.

Hedge Ratio (HR) = Change in value of positionChange in value of futures

An illustration of the use of the Hedge Ratio is outsidethe scope of this document and will be the subject offuture documentation.

Using the Hedge Ratio to Increase theEffectiveness of the Hedge

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As the March expiration approaches, assume that therates for the JIBAR Futures contracts are as follows:

The profit that the trader thus made on hisDecember Futures position is as follows:

Profit on December Futures = Number of contractsx change in futures yield (basis points)x basis point value= 100 x (7.92% - 7.8%) x R2.5/bp= 100 x 12 bp x 2.5= R 3,000.

On the other hand, the loss made on the MarchFutures positions is as follows:

Profit on March Futures = Number of contracts xchange in futures yield (basis points)x basis point value= 100 x (7.164%-7.2%) x R2.5/bp= 100 x (-3.6 bp) x 2.5= -R 900.

The total profit made by the trader is thus:

Profit on December Futures position – Loss onMarch Futures position= R 3,000 – R 900= R 2,100.

This type of strategy is known as: 'buying the spread',i.e. buy near date and sell far date and profiting froman expansion of the spread.

Conversely, suppose the trader expects longer termrates to fall relative to near term rates. The trader cansimulate this trade by selling the near date contract(say March at 7.164) and buying the far date (saySeptember at 7.55), at a differential of +38.6. Thistype of strategy is known as: 'selling the spread', i.e.sell near date and buy far date and profiting from adecline in the spread.

Table 3: Strip of JIBAR Futures Prices

These actions can be summarised as follows:

Yield curve expected to steepen (or steepen morethan the market expects):

Yield curve expected to flatten or invert (or flattenor invert more than the market expects):

Johannesburg Stock Exchange –

Interest Rate Products

Tel: +27 (0) 11 520 7000

Email: interestrates@jse.co.za

www.jse.co.za

“Buy the curve,” i.e., buy nearby and selldeferred futures.

“Sell the curve,” i.e., sell nearby and buydeferred futures.

Contact information

Mar 'xx Jun 'xx Sep 'xx Dec 'xx

7.200% 7.530% 7.800% 7.920%

Finding Jibar Futures Rates

Vendor Code

REUTERS 0#JBAF:YX

BLOOMBERG JBRA <comdty>

INET Example: JBAFM0(Jun 2010 contract) wherethe fifth digit representsthe standard futurescalendar month as follows:

F = JanuaryG = FebruaryH = MarchJ = AprilK = MayM = JuneN = JulyQ = AugustU = SeptemberV = OctoberX = NovemberZ = December

Disclaimer: This document is intended to provide general information regarding the JSE Limited (“JSE”) and its products and services, and is not intended to, nor does it, constitute investment or otherprofessional advice. It is prudent to consult professional advisers before making any investment decision or taking any action which might affect your personal finances or business. All information asset out in this document is provided for information purposes only and no responsibility or liability (including in negligence) will be accepted by the JSE for any errors contained in, or for any loss arisingfrom use of, or reliance on this document. All rights, including copyright, in this document shall vest in the JSE. “JSE” is a trade mark of the JSE. No part of this document may be reproduced or amendedwithout the prior written consent of the JSE.

Compiled: February 2010.

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