Question

The December Eurodollar futures contract is quoted as 98.40 and a company plans to borrow $8 million for three months starting in December at LIBOR plus 0.5%.
(a) What rate can then company lock in by using the Eurodollar futures contract?
(b) What position should the company take in the contracts?
(c) If the actual three-month rate turns out to be 1.3%, what is the final settlement price on the futures contracts?
Ignore timing mismatches between the cash flows from the Eurodollar futures contract and interest rate cash flows.

Answer 1

Hey, come on... You all seem posting similar problems. They must be from the same text book. I already posted the answer to this one below. Here I repeat.

"Start quote: "Eurodollar futures prices are determined by the market’s forecast of the 3-months LIBOR interest rate expected to prevail on the settlement date. The settlement price of a contract is defined to be 100.00 minus the official British Bankers Association fixing of 3-months LIBOR on the contract settlement date." End quote Since December Eurodollar futures are quoted at 98.40, then the expected 3-months LIBOR in December is expected to be 1.60%; therefore, the answer to (a) is 1.60%. Start quote: "A single Eurodollar future is similar to a forward rate agreement to borrow or lend $1 million for 3 months starting on the contract settlement date. Buying the contract is equivalent to lending money, and selling the contract short is equivalent to borrowing money." End quote Since the company plans to borrow $8 million it should sell short eight Eurodollar futures to get $8 million in December. This is the answer to (b). Suppose the actual 3-month LIBOR turns out to be 1.30%. This implies that the price of futures has risen to 98.70 and the seller will have to pay the buyer 1,000,000 x 0.3% x 90/360 = 750 $ per contract. Since the company sold eight contracts it will have to pay 6,000 $ to the buyer of the futures in 3-months time since December. Thus, the final settlement price on the futures is $6,000"