Interest Rate Risk
Last updated
Last updated
How bad can interest rate risk be? You might wonder if you can avoid losing money by entering and exiting a trade at the same interest rate. But that’s not always the case. 😊
Let me explain why. 👇
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When you enter a trade, you pay a liquidity fee to the market maker. This fee is proportional to the duration of your trade. The longer you hold your position, the more you pay. 💸
0.3% per trade
But if you exit too soon, you don’t get enough time to earn interest on your fCash. So you end up paying more than you earn. 😅
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Here’s an example to illustrate this point. 📈
Suppose you enter a trade with 100 Cash and 100 fCash at 5% interest rate. You hold your position for 6 days and then exit at the same interest rate.
How much do you think you will make or lose? 🤔
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If you do the math, you will find out that you will lose 0.53 Cash in this trade. That’s a negative APY of -38.5%. Oops! 😅
Why? Because the liquidity fee you paid was not fully recovered with the interest you earned so far
That’s not ideal, is it? 🤷♂️
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But that’s not all. 😊
You can also lose money if the interest rate changes while you are in the trade. Remember, we talked about how the exchange rate between fCash and Cash depends on the interest rate? 🤓
Well, if the interest rate goes up, your fCash becomes less valuable. 🙃
[LINK]
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Here’s another example to show you how this works. 📉
Suppose you enter a trade with 100 Cash and 100 fCash at 5% interest rate. You hold your position for 3 months and then exit at a 7% interest rate.
How much do you think you will make or lose? 🤔
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If you do the math again, you will find out that you will lose 0.78 Cash in this trade. That’s a negative APY of -3.13%. Oh well! 😅
Why? Because your fCash is now worth only 99.22 Cash, you still have to pay back 100 Cash.
That’s also not ideal, is it? 🤷♀️
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So how can you avoid losing money in these scenarios? 🤷♂️
One way is to hold your position for longer, until the exchange rate between fCash and Cash approaches 1:1 as the maturity date gets closer. 📅
But how long should you hold your position? 🕰️
That’s where break-even analysis comes in handy. 🔥
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Break-even analysis tells you how many days you need to hold your position to make zero profit or loss, given a certain exit interest rate. 🧮
For example, if the exit interest rate is 7%, and you want to break even, you need to hold your position for 130 days. 🗓️
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That’s it for this thread. I hope you learned something new today about interest rate risk and how to manage it. 💯
If you have any questions or feedback, feel free to drop them in the comments below. 👇
And don’t forget to like, retweet and follow me for more awesome content on #fCash #trading #finance #interestrates and more! 😎👍
