Question

The treasurer for Pittsburgh Iron Works wishes to use financial futures to hedge her interest rate exposure. She will sel fe Treasury futures contracts at $165,000 per contract. It is July and the contracts must be closed out in December of this year. Long-term interest rates are currently 15.30 percent. If they increase to 16.50 percent, assume the value of the contracts will go dawn by 10 percent. Also if interest rates do increase by 1.2 percent assume the firm will have additional interest expense on its business loans and other commitments of $103,000. This expense, of course, will be separate from the futures contracts. a. What will be the profit or loss on the futures contract if interest rates increase to 16.50 percent by Decermber when the contract is closed out? PoIuures conltaects b-1. After considering the hedging, what is the net cost to the firm of the increased interest expense of $103,000? Net cost

Answer 1

Ans (1):

Value of Contract (When Interest rate is 15.30%) = $165000 per contract * 5 contracts = $825,000
Value of Contract (Interest rate is 16.50%) = ($165000 - 10%) per contract * 5 contracts = $742,500

Profit/(loss) on futures contract on Maturity: $742,500 - $825,000 = ($82,500)

Ans (2):

Net Cost to the Firm = Additional Interest Exposure - Loss on Futures Contract
= $103,000 - $82,500
= $20,500

"If you have any Query, then please put it in the comment box."