Question

If the 1 month Federal Funds Futures price is 97.50 and the 6 month Federal Funds Futures price is 96.50, the market is anticipating that in the coming months, the Fed Funds interest rate will do what?

Select one:

A. cannot tell from the information

B. increase

C. decrease

D. remain the same

Clear my choice

Answer 1

Answer: Option (C)

Fair Future Price = Spot Price (1+ Interest Rate)

6 Month Future Price = Spot Price (1+ Interest Rate for 6 Months)

6 Month Future Price = 1 month Futures Price (1+ Interest Rate for 5 Months)

96.5 = 97.5 ( 1+ Interest Rate for 5 Months)

1 + Interest Rate for 5 Months = 96.5/97.5

1 + Interest Rate for 5 Months = 0.9897

We can observe that Interest Rate is less than 1. (As adding Interest rate to 1 is resulting in 0.9897 (number less than 1)).

i.e., Interest Rates will decrease.