Question

First American Bank is planning to make a $20 million short-term loan to Midwest Mining Company....

First American Bank is planning to make a $20 million short-term loan to Midwest Mining Company. In the loan contract, Midwest agrees to pay the principal and an interest of 12 percent (annual) at the end of 180 days. Since First American sells more 90-day CDs (Certificates of Deposits) than 180-day CDs, it is planning to finance the loan by selling a 90-day CD now at the prevailing LIBOR of 8.25 percent (compounded annually), then 90 days later (mid-September) sell another 90-day CD at the prevailing LIBOR. The bank would like to minimize its exposure to interest rate risk on its future CD sale by taking a position in a September Eurodollar futures contract trading at 92 (IMM index).

a) Should the bank buy or sell Eurodollar futures contracts? Explain why.

b) How many September Eurodollar futures contracts would First American Bank need in order to effectively hedge its September CD sale against interest rate

changes?

Homework Answers

Answer #1

a) Eurodollar futures provide an effective means for companies and banks to secure an interest rate for money it plans to borrow or lend in the future. In our example after 90 days First American Bank need to sell another 90-day CD at the prevailing LIBOR. Bank should sell Eurodollar futures contracts in order to hedge the interest rate risk on its future CD sale.

b) In mid-September First American Bank needs to borrow $20 million. As each eurodollar futures contract represents a $1 million time deposit with a three-month maturity. The First American Bank can hedge against an adverse move in interest rates during that three-month period by short selling twenty eurodollar futures contracts, representing the $20 million needed.

Know the answer?
Your Answer:

Post as a guest

Your Name:

What's your source?

Earn Coins

Coins can be redeemed for fabulous gifts.

Not the answer you're looking for?
Ask your own homework help question
Similar Questions
First American Bank is planning to make a $20 million short-term loan to Midwest Mining Company....
First American Bank is planning to make a $20 million short-term loan to Midwest Mining Company. In the loan contract, Midwest agrees to pay the principal and an interest of 12 percent (annual) at the end of 180 days. Since First American sells more 90-day CDs (Certificates of Deposits) than 180-day CDs, it is planning to finance the loan by selling a 90-day CD now at the prevailing LIBOR of 8.25 percent (compounded annually), then 90 days later (mid-September) sell...
In March, a bank short-term investment manager has $1 million in 90 day Tbills on its...
In March, a bank short-term investment manager has $1 million in 90 day Tbills on its balance sheet that it plans to sell in June for liquidity purposes, and is worried about interest rates rising (i.e. prices falling) in the next few months, which would cause the value of the T-bills to fall. The current (spot) discount yield is 1.10% (i.e. a Discount % price of 98.90%) for a 90-day T-bill. a. What is the price for the $ 1...
Suppose that it is January, and your bank makes a $1 million loan with a one-year...
Suppose that it is January, and your bank makes a $1 million loan with a one-year maturity and carries 4% fixed interest rate. The bank initially finances the loan by issuing a $1 million 3-month Eurodollar CD paying 2.5%. After the first three months, the bank expects to finance the loan by issuing another $1 million 3-month Eurodollar CD in April (assume the rate becomes 2.9%), and another $1 million 3-month Eurodollar CD in June (assume the rate becomes 2.4%),...
INTRO NewForm IT is a seven-year-old IT consulting company founded in 2012 that provides services to...
INTRO NewForm IT is a seven-year-old IT consulting company founded in 2012 that provides services to small businesses in their local and regional area. NewForm employs 83 people, 61 of whom are IT professionals/ consultants. NewForm is struggling financially; it has not met its revenue projections in the last five quarters. NewForm has suffered excessive leadership turnover in the past three years. The original founders sold NewForm in 2015; one of them, James Stanton, remained on as CHRO but sold...
INTRO NewForm IT is a seven-year-old IT consulting company founded in 2012 that provides services to...
INTRO NewForm IT is a seven-year-old IT consulting company founded in 2012 that provides services to small businesses in their local and regional area. NewForm employs 83 people, 61 of whom are IT professionals/ consultants. NewForm is struggling financially; it has not met its revenue projections in the last five quarters. NewForm has suffered excessive leadership turnover in the past three years. The original founders sold NewForm in 2015; one of them, James Stanton, remained on as CHRO but sold...
What tools could AA leaders have used to increase their awareness of internal and external issues?...
What tools could AA leaders have used to increase their awareness of internal and external issues? ???ALASKA AIRLINES: NAVIGATING CHANGE In the autumn of 2007, Alaska Airlines executives adjourned at the end of a long and stressful day in the midst of a multi-day strategic planning session. Most headed outside to relax, unwind and enjoy a bonfire on the shore of Semiahmoo Spit, outside the meeting venue in Blaine, a seaport town in northwest Washington state. Meanwhile, several members of...
What role could the governance of ethics have played if it had been in existence in...
What role could the governance of ethics have played if it had been in existence in the organization? Assess the leadership of Enron from an ethical perspective. THE FALL OF ENRON: A STAKEHOLDER FAILURE Once upon a time, there was a gleaming headquarters office tower in Houston, with a giant tilted "£"' in front, slowly revolving in the Texas sun. The Enron Corporation, which once ranked among the top Fortune 500 companies, collapsed in 2001 under a mountain of debt...
Discuss ethical issues that can be identified in this case and the mode of managing ethics...
Discuss ethical issues that can be identified in this case and the mode of managing ethics Enron finds itself in this case. How would you describe the ethical culture and levels of trust at Enron? Provide reasons for your assessment. THE FALL OF ENRON: A STAKEHOLDER FAILURE Once upon a time, there was a gleaming headquarters office tower in Houston, with a giant tilted "£"' in front, slowly revolving in the Texas sun. The Enron Corporation, which once ranked among...
Discuss how the respective organizations’ relations with stakeholders could have potentially been affected by the events...
Discuss how the respective organizations’ relations with stakeholders could have potentially been affected by the events that took place at Enron and how the situation could have been dealt with differently to prevent further damage? THE FALL OF ENRON: A STAKEHOLDER FAILURE Once upon a time, there was a gleaming headquarters office tower in Houston, with a giant tilted "£"' in front, slowly revolving in the Texas sun. The Enron Corporation, which once ranked among the top Fortune 500 companies,...
ADVERTISEMENT
Need Online Homework Help?

Get Answers For Free
Most questions answered within 1 hours.

Ask a Question
ADVERTISEMENT