FIN 4324 Assignment 5

Name:

[1-2] A treasurer of Company A expects to receive a cash inflow of $15 million in 90 days.

The treasurer expects short-term interest rates to fall during the next 90 days. In order to

hedge against this risk, the treasurer decides to use an FRA that expires in 90 days and is

based on 90-day LIBOR. The FRA is quoted at 5%. At expiration, LIBOR is 4.5%.

Assume that the notional principal amount on the contract is $15 million.

1. Indicate whether the treasurer should take a long or short position to hedge interest rate

risk.

2. Calculate the gain or loss to Company A as a consequence of entering the FRA.

3. Your financial firm needs to borrow $500 million by selling time deposits with 180-

day maturities. If interest rates on comparable deposits are currently at 3.5 percent,

what is the cost of issuing these deposits? Suppose interest rates rise to 4.5 percent.

What then will be the cost of these deposits? What position and types of futures contract

could be used to deal with this cost increase?

4. By what amount will the market value of a Treasury bond futures contract change if

interest rates rise from 5 to 5.25 percent? The underlying Treasury bond has a duration

of 10.48 years and the Treasury bond futures contract is currently being quoted at 113-

06. (Remember that Treasury bonds are quoted in 32nds.)

5. Morning View National Bank reports that its assets have a duration of 7 years and its

liabilities average 1.75 years in duration. To hedge this duration gap, management plans

to employ Treasury bond futures, which are currently quoted at 112-170 and have a

2

duration of 10.36 years. Morning View’s latest financial report shows total assets of

$100 million and liabilities of $88 million. Approximately how many futures contracts