Question

The firm will receive cash inflow of $30 million on June 20 which needs to be parked for a period of 3 months ending on sep 19. The CFO believes the interest rates will start falling and wishes to hedge against this. She notes that the june euro dollar futures (expiring on june 20) is at 96

a. Write down the position that she should take on the euro dollar contracts. The final closing price on June 20 was 95

b. Compute the interest earned when the $ 30 million was invested on June 20 for 3 months

c. Compute the loss / gain on the euro dollar futures

d. Assuming the loss/ gain on the euro dollar futures were realised on sep 19. what was the total cash inflow on sep 19

e. Therefore what was the effective interest rate using this strategy

Answer 1

A). Firm should go long 30 eurodollar futures.

B). If we have invested 30 million on June 20 then 4%

I.e. Eurodollar futures prices are expressed numerically using 100 minus the implied 3-month U.S. dollar LIBOR interest rate. In this way, a eurodollar futures price of $95.00 reflects an implied settlement interest rate of 5%, or 100 minus 95.

C).gain

Eurodollar future price = 10,000*{100-[0.25*(100-Z)]}

Here Z = 96-95 =1

Therefore ED future price = 752,500

D). Inflow

Eurodollar future price = 10,000*{100-[0.25*(100-Z)]}

Here Z = 95

Therefore ED future price = 987,500 per contract

We have entered in 30 contract = 30* 987,500= 29,625,000

E). Effective interest rate was 4%