T managers to seek out new and more sophisticated financial planning tools to cope with their more complex financial problems. This awakening need for a more effective risk-trader mechanism to protect against the growing uncertainty and volatility of interest rates directly led to the development of interest-rate futures. The recent emergence and rapid growth of interest-rate futures markets provides financial instituhs with a new planning tool which can potentially reduce uncertainty and lower risk exposure in the formulation and implementation of financial decisions. For example, funds managers who anticipate issuing CDs in the future and wbo beiieve interest rates may rise may be able to secure a lower effective rate of interest by short hedging with futures.
The purpose of this d e is to evaluate the 3and &month hedging with T-bill futures of fluctuations in negotiable bank CD rates over the 1976-1980 time period. A statistical analysis of the performance of routinely hedged positions versus unhedged positions in CDs is examined during this time. The perspective of a bank funds manager is taken who desires to issue CDs as part of his liability management program. Data will be analyzed on a weekly basis since most managers do not trade on a daily basis. Furthermore, taxes and foregone interest on variation margin calls will be ignored; however, transactions cost will be taken into account.
One may question why cross hedging with T-bil futures should even be considered when a futures contract for domestically issued CDs has recently become available. The question is one of liquidity. If the CD futures market were sufficiently liquid, then the direct hedge should be chosen to avoid risk of loss from spread changes between the two markets. If it is not sufficiently liquid, then hedgers might select the cross hedge in the T-bill futures contract.
On this latter point, a commonly used measure of liquidity is open interest. In examining the International Monetary Market's IMM CD contract, we found that