Question

Chrysler LLC, the now privately held company sold by DaimlerChrysler, must pay a floating rate interest three months from now. It wants to lock in thee interest payments using interest rate futures contracts. Interest rate futures for three months from now settles at 96.77 for a yield of 3.23% per annum.

a. Should Chrysler buy or sell the interest rate futures contract?

Answer 1

As the company is paying floating rate interest, to protect itself from fluctuations in Interest rates , it should get floating rate payments from an instrument so that it can hedge itself.

The hedging can be achieved by using an Eurodollar Futures contract, the contract increases in value if the interest rate decreases. As the company will pay floating rate the company must SELL the Eurodollar futures. Any increase in Interest rates will lead to a profit from the Eurodollar position, offsetting the loss in the floating rate payments and vice versa,