Question

Dudley Savings Bank wishes to take a position in Treasury bond futures contracts, which currently have a quote of 124 − 100. Dudley Savings thinks interest rates will go down over the period of investment. The face value of the bond underlying the futures contract is $100,000.

a. Should the bank go long or short on the futures contracts?
b. Given your answer to part (a), calculate the net profit to Dudley Savings Bank if the price of the futures contracts increases to 124 − 240. (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places. (e.g., 32.16))
c. Given your answer to part (a), calculate the net profit to Dudley Savings Bank if the price of the futures contracts decreases to 123 − 300. (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places. (e.g., 32.16

a.	The futures contracts	Long
b.	Net profit
c.	Net profit

Answer 1

a. Interest rates are expected to reduce, so treasury bond prices will rise and accordingly bank should take a long position on the futures contracts.

b. If price becomes 124-240 from 124-100, then:

Purchase price=1,00,000*124 10/32%=$1,24,312.5

Sale price=1,00,000*124 24/32%=$1,24,750

Net profit=$(1,24,750-1,24,312.5)=$437.50

c. If price becomes 123-300 from 124-100, then:

Purchase price=1,00,000*124 10/32%=$1,24,312.5

Sale price=1,00,000*123 30/32%=$1,23,937.5

Net profit=$(1,23,937.5-1,24,312.5)=-$375