Two months from today you plan to borrow $3 million for 6 months at LIBOR.You hedge your interest rate risk with a euro dollar futures contract priced at 93.6.If settled in arrears,what is your payment if the 6-month LIBOR is 2.5% in two months?
A) $8,500
B) $10,500
C) $13,500
D) $15,500

Question

Quizplus · Accepted Answer

The payment can be calculated by understanding the mechanics of a Eurodollar futures contract and the relationship with LIBOR. The Eurodollar futures price is quoted as 100 minus the interest rate, so a price of 93.6 implies an interest rate of 6.4% (100 - 93.6). If the 6-month LIBOR rate in two months is 2.5%, the change in interest rate from the futures contract price is 6.4% - 2.5% = 3.9%. The payment is calculated on the basis of $1 million per basis point (0.01%) for a 6-month period. Therefore, the payment is 3.9% (or 390 basis points) times $1 million, which equals $3.9 million for a full year. However, since the loan is for 6 months, the amount is halved, resulting in $1.95 million. The futures contract is for $3 million, so the calculation is based on this amount, leading to a payment of $10,500 (3.9% of $3 million for 6 months).

Two Months from Today You Plan to Borrow $3 Million