Assume a corporation is receiving a large amount of funds in the near future. The company plans to use the funds to purchase municipal bonds. Also assume that the company is concerned that interest rates will decrease before the purchase date, which would make the municipal bonds more expensive. In order to hedge against this possibility, the company should ____ MBI futures contracts. If interest rates decrease, the futures contract will generate a ____.

Question

Quizplus · Accepted Answer

If interest rates decrease, the price of municipal bonds increases, making a futures contract to buy these bonds at today's prices profitable. Hence, purchasing MBI futures contracts would hedge against the risk of rising bond prices due to falling interest rates, and if interest rates decrease as feared, the futures contract would indeed generate a gain.

Assume a Corporation Is Receiving a Large Amount of Funds