Page 347 - AFM Integrated Workbook STUDENT S18-J19

Answers

Chapter 11

Question 1

Astar Co is expecting to borrow $20 million for six months from 1 September.

The finance director predicts that the current interest rate will rise from its
current level of 4%, so she has decided to use $1,000,000 3-month interest
rate futures contracts to hedge the risk.

Futures prices:

June contracts 95.80

September contracts 95.58

Assume that today is 31 May.

Required:

Calculate the result of the relevant futures hedge, assuming that interest
rates have risen to 5% and the futures price has moved to 95.10 by
1 September.

Solution

Set up hedge

Buy or sell futures? Sell, since we are borrowing

Number of contracts = (20,000,000/1,000,000) × 6/3 = 40

Which expiry date? September, since it expires soonest after the transaction
date of 1 September.

Contact the exchange: We need to sell 40 September contracts at a price of
95.58

Result of hedge

On 1 September – assume interest rate is 5% and futures price is 95.10:

335