Question

28. Clarke plans to satisfy cash needs in nine months by selling its Treasury bond holdings for $4 million. However, Clarke is concerned that interest rates might increase over the next three months. To hedge against this possibility, Clarke plans to sell Treasury bond futures. Thus, Clarke sells_ futures contract for a price of 99-12. Assuming that the actual price of the futures contract declined to 97-20, Clarke would make a of $ _ from closing out the futures position. a. 40; profit; $76,800 b. 40; loss; $76,800 c. 50; profit; $70,000 d. 40; profit; $70,000 e. none of the above ANS: D

Answer 1

Amount to be hedged = $4,000,000

Amount of T Bond Futures = $100,000

Number of contracts to be sold = $4,000,000/$100,000= 40

Now, we have sold the future at 99-12

But the actual futures price is 97-20

The size of tick is 32. (For example 99-12 means 99 and 12/32 of the face value)

Since, we are selling the future at a higher price, we are in a profitable position. Let's calculate the profit:

Profit = Number of contracts * Difference of Ticks * $31.25

Difference of Ticks between 99-12 and 97-20 is 56 (32+24)

Profit = 40 * 56 * 31.25 = $70,000

The answer is Option D.

Note: $31.25 is the Minimum Tick value.