Question

Suppose that today is Monday, February 17th and you have a loan of $10,000,000 outstanding, on which you will have to make a floating-rate interest rate payment on Friday, February 21. The interest payment is determined based on a 3-month LIBOR rate on that day. You fear that in the next several days the rate might rise. So you hedge yourself by trading Eurodollar futures. Assume that you enter into the position at close of day on Monday, February 17th.

a. In order to hedge yourself, which position in Eurodollar futures will you take (i.e. buy or sell, contract maturity, and the number of contracts)?

b. What is the value of your futures position on Monday, February 17th?

c. What is your daily gain or loss on your futures position (on Tuesday, Wednesday, Thursday, and Friday)?

d. What is the interest rate payment that you have to make on Friday, February 21, on your $10,000,000 loan?

e. What is the net cost to you, taking into account the gains/losses on your hedge, plus the interest payment on the loan (ignore the time value of money)?

DATA:

Daily Settlements for Eurodollar Futures (FINAL)Trade Date: 02/18/2020 (Tuesday)

Month	Open	High	Low	Last	Change	Settle	Estimated Volume	Prior Day Open Interest
MAR 20	98.3425	98.3500	98.3350	98.3450	+.0025	98.3475	327,175	1,515,029
APR 20	98.3650	98.3850	98.3650	98.3800	+.0150	98.3850	41,472	166,515
MAY 20	98.4100	98.4350	98.4050	98.4250	+.0150	98.4300	17,575	27,196
JUN 20	98.4450	98.4800	98.4350	98.4650	+.0250	98.4750	316,825	1,472,443
JLY 20	98.5100	98.5100	98.4750A	98.5100	+.0250	98.5050	1	507

Daily Settlements for Eurodollar Futures (FINAL)Trade Date: 02/20/2020 (Thursday)

Month	Open	High	Low	Last	Change	Settle	Estimated Volume	Prior Day Open Interest
MAR 20	98.3325	98.3525	98.3275	98.3475	+.0150	98.3475	281,404	1,539,280
APR 20	98.3650	98.3900	98.3600	98.3850	+.0200	98.3850	36,936	172,311
MAY 20	98.4100	98.4450	98.4100	98.4350	+.0250	98.4350	17,969	34,572
JUN 20	98.4550	98.4950	98.4450	98.4800	+.0300	98.4850	311,053	1,512,715
JLY 20	98.5000	98.5250B	98.5000	98.5250B	+.0300	98.5150	165	507

Daily Settlements for Eurodollar Futures (FINAL)Trade Date: 02/21/2020 (Friday)

Month	Open	High	Low	Last	Change	Settle	Estimated Volume	Prior Day Open Interest
MAR 20	98.3450	98.3700	98.3450	98.3575	+.0175	98.3650	340,805	1,518,942
APR 20	98.3850	98.4250	98.3850	98.4100	+.0300	98.4150	22,384	173,882
MAY 20	98.4400	98.4900	98.4400	98.4750	+.0450	98.4800	22,934	37,017
JUN 20	98.4850	98.5500	98.4800	98.5300	+.0500	98.5350	444,875	1,529,526
JLY 20	98.5300	98.5800B	98.5300	98.5650	+.0500	98.5650	162	517

3-month LIBOR rate:

February 17, 2019                   1.69288

February 18, 2019                   1.69463

February 19, 2019                   1.69600

February 20, 2019                   1.68275

February 21, 2019                   1.67925

Answer 1

Assumptions are taken to solve:-
1.) No Initial Margin & Mark to Market Margin need to be maintained.
2.) Contract Size of Eurodollar future is $1 Mln.
3.) Data for Wednesday has not been provided it is assumed that Wednesday was a holiday and market was closed.
4.) For the purpose of the question, it has been assumed that contracts could be taken into fractions.

Answers:-

a.) As there is a risk of a rise in interest rates we will be taking a Short position in Eurodollar Futures i.e. Selling Eurodollar future of maturity equivalent to that of LIBOR Rate used i.e. 3 Months Eurodollar. In our case, we will short May 20 Eurodollar future. We will be taking 10.18 contracts. (However, in practice only 10 contracts could be sold and rest exposure will not be hedged).

b.) Value of Futures on Initiation date is always Zero.

c.)

				$Mln
Contracts Taken = 10.18	Value @ start	Value at close	Gain/(Loss)	Total Gain/(loss)
Monday 17th	NA	98.41	0	0
Tuesday 18th	98.41	98.43	-0.02	-203600
Wednesday 19th	98.43	98.43	0	0
Thursday 20th	98.41	98.435	-0.025	-254500
Friday 21st	98.44	98.48	-0.04	-407200

d.) Interest Payment to be made on Maturity Date is the 3-Months LIBOR Rate on that day

Amount of Loan	3 Months LIBOR Rate	Days Outstanding	Interest Per day	Total Interest	Amount to be paid on Maturity
1,00,00,000	1.67925	4 days	46,006.85	1,84,027.40	1,01,84,027.40