question archive You are given the following data on the 3-month dollar interest rate futures contract
You are given the following data on the 3-month dollar interest rate futures contract
Subject:FinancePrice:2.86 Bought3
You are given the following data on the 3-month dollar interest rate futures contract. The contract has a notional size of $1 million.
December 2021 Dollar futures contract 95.50
i. Explain what the sale of such a contract implies.
ii. If you think 3-month dollar interest rates in December 2021 will be 7% would you buy or sell the contract? Explain your reasoning and the profits you can expect if you are correct.
iii. Briefly explain how a Corporate Treasurer who is looking to lend $2 million of funds for 3 months from December 2021 might use the above contract to hedge interest rate risk.
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i) Interest Rate Futures Price of $95.5 means current Interest Rate is (100-95.5) = 4.5%
ii) If expected Interest Rate in Future is 7 %, Price of Futures Contract will be (100-7) = $93
As Price is Expected to Fall, Futures Contract should be Shorted i.e. Sold
Expected Profit on the above sale = Notional Size of Contract*(Current Price-Expected Price)/100 = 1000000*(95.5-93)/100 = 1000000*2.5/100 = $ 25000
iii) If interest rates increases , the futures prices will fall, so we should sell the futures contracts now (at the relatively high price) and buy later (at the lower price). The gain on futures can be used to offset the lower interest earned.
