Corporation taking out a loan


Hedge exposure to fluctuating interest rates


SOFR strips


Loans are often based on a term rate plus a fixed premium. When the interest rate resets at different points throughout the life of a loan, market participants are exposed to the risk of rising or falling rates between each reset date. A SOFR strip is defined as a series of consecutive quarterly SR3 futures contracts.


In this scenario, it is March and a corporation anticipates borrowing $100 million for two years at three-month Term SOFR plus a fixed premium, reset quarterly. The corporation already knows the rate for the first 90 days, but they remain exposed to the risk that rates will rise during the seven following quarterly loan reset dates.

The two-year loan can be decomposed into seven quarterly strips. The corporation can sell three-month SOFR futures (SR3) in order to hedge the risk of rising rates.

To determine how many futures contracts to sell, the corporation will first determine the BPV of the loan, then use that to construct a hedge ratio.

BPV = $100,000,000 x (630/360) x 0.01% = $17,500

HR = $17,500 / $25 = 700 SR3 sell to hedge risk

Since the floating rate loan can be thought of as seven successive 90-day loans, the BPV and hedge ratio could also be calculated on an individual loan level.

BPV = $100,000,000 x (90/360) x 0.01% =$2,500

HR = $2,500 / $25 = 100 SR3 sell per loan to hedge risk

The corporation hedges each loan period separately by selling a strip of three-month SOFR futures.

White June Sell 100 White Jun futures
White September Sell 100 White Sep futures
White December Sell 100 White Dec futures
White March Sell 100 White Mar futures
Red June Sell 100 Red Jun futures
Red September Sell 100 Red Sep futures
Red December Sell 100 Red Dec futures


In this scenario, the corporation’s hedge is evenly distributed along the forward curve to hedge future potential rate increases.


SOFR futures can be used in succession (strips) to manage interest rate risk. Since SOFR futures cover 90-day periods, the number of contracts needed to cover the length of the loan will grow as the loan term increases. Because of this, strips can be also packaged into packs and bundles to allow for the purchase or sale of multiple strips in a single transaction.

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Interested in learning more about packs and bundles? Check out this article:
SOFR Futures Packs and Bundles

Learn more about SOFR in this course:
Introduction to SOFR

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