Question

[SHOW STEPS AND CALCULATION]

It’s April 2019. In December 2019 a firm needs to borrow $75,000,000 for 9 months. If they used Eurodollar futures to guard against a rise in LIBOR, which maturity month should they use? Should they buy or sell Eurodollar futures?

Factoring in the present value of interest, how many Eurodollar futures should this company buy or sell today? Assume 3-month, 6-month, 9-month, and 17-month LIBOR rates are 2.5%, 2.45%, 2.4%, and 2.3% respectively.

Answer 1

Firm needs to borrow $75,000,000
So, to guard against LIBOR rise, it should Buy 75,000,000 Euro futures contract.
Firm has to borrow in 9 months.
So, 9 months futures 2.4% should company Buy.
Value of futures in 9 months if buy = Market rate - Futures rate
Suppose, if market interest rate is 2%,
Interest payable on loan = -2%
Loss on futures(2%-2.4%) = -0.4%
		_________
Net cost of loan = -2.4%
Suppose, if interest rate is 3%,
Interest payable on loan = -3%
Profit on futures(3%-2.4%) = 0.6%
		_________
Net cost of loan = -2.4%
So, in any situation, cost of loan shall be 2.4%, if 9 months futures is long.