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1. It is April 2019. A US company needs to borrow $100,000,000 for three months starting...

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Finance

1. It is April 2019. A US company needs to borrow $100,000,000for three months starting five months from now. The current 3-monthLIBOR is 2.5%. The company is afraid that rates may rise duringthose five months before it obtains the loan. Should the companybuy or sell Eurodollar futures? And how many (ignoring the presentvalue of the basis point change)?

Which month should the futures settle/expire?

Assume that the appropriate Eurodollar future is trading at97.4. What interest does the company pay if the 3-month LIBOR ratefinishes at 95 (factoring in the gain/loss of the Eurodollarfutures contracts)? Or finishes at 98? Assume each month has 30days.

Answer & Explanation Solved by verified expert
3.9 Ratings (679 Votes)
This is a very interesting question and needs a thorough understanding of the Eurodollar futures to answer I will try to break down the concepts and explain the answer by logical steps The company needs to borrow the money in future The adverse impact for borrowing would be the interest rates going up Hence we need a hedging instrument that will protect against rising interest rate risk The instrument used here is the Eurodollar futures EDF The underlying for EDF is a Eurodollar time deposit which at the rate of 3months LIBOR We will need to shortsell the EDF to    See Answer
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Transcribed Image Text

1. It is April 2019. A US company needs to borrow $100,000,000for three months starting five months from now. The current 3-monthLIBOR is 2.5%. The company is afraid that rates may rise duringthose five months before it obtains the loan. Should the companybuy or sell Eurodollar futures? And how many (ignoring the presentvalue of the basis point change)?Which month should the futures settle/expire?Assume that the appropriate Eurodollar future is trading at97.4. What interest does the company pay if the 3-month LIBOR ratefinishes at 95 (factoring in the gain/loss of the Eurodollarfutures contracts)? Or finishes at 98? Assume each month has 30days.

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