Question

In: Finance

A bank entered into an FRA to lend $12m starting in March and ending in December...

A bank entered into an FRA to lend $12m starting in March and ending in December at 3.00% ACT/360. It decided to hedge this exposure using Eurodollar futures contracts. It goes short 12 contracts each of the March, June and September contracts.

Briefly explain why the bank chose

  1. Why the bank went short rather than long
  2. Why 12 contracts
  3. Why did it trade the March, June and September contracts rather than other contracts.

Solutions

Expert Solution

A short hedge is one where a short position is taken on a futures contract. It is typically appropriate for a hedger to use when an asset is expected to be sold in the future. Alternatively, it can be used by a speculator who anticipates that
the price of a contract will decrease. Whereas the  long hedge is one where a long position is taken on a futures contract. It is a typically appropriate for a hedger to use when an asset is expected to be bought in the future. Alternatively, it can be used by a speculator who anticipates that the price of a contract will increase. Here the volatility is the key factor to go on to short contract by the bank because the financial markets are most exposed to sensitive changes. By having 12 contracts we can optimize our gain and minimize the risk and the loss. Here there are seperate predictions on the basis so the range of estimation will be typically cover all the ends. These are the months where the companies and all over state their performance and that drives the financial markets and that decides the value of the currency and it would be wiser to choose these months rather other periods.


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