Question

Ms. Hunter is a money market manager. In July, she anticipates needing cash in September that

she plans to obtain by selling ten $1 million face value T-bills she currently holds. At the time of

the anticipated September sale, the T-bills will have a maturity of 91 days. Suppose there is a

September T-bill futures contract trading at a discount yield of 6%.

a) Describe the interest rate risk that she is facing. Is it better if interest rates

increase or decrease?

b) How could she lock in the selling price on her T-bills?

c) What will be the locked in sale price?

Answer 1

Qa:

The interest rate risk is that suppose if the market interest rate goes up due to some reason, as per the inverse relation of debt securities and interest rate, the price of the T bill will go down. Due to this her selling price will be very less than what she would have paid earlier to buy the security. This will cause a loss for her.

Qb:

She can lock in the price by selling the future contract with a discount yield of 6%. This will give her the right to sell the securities as mentioned in the contract even if the interest rate goes up.

Qc:

Discount yield =[(Face value- Purchase price)/Face value] * [360/no of days]

.06=[1 -(purchase value/1000000)] *(360/91)

Purchase price=984833.33 --- locked in sale price