The treasurer for Pittsburgh Iron Works wishes to use financial futures to hedge
ID: 2759520 • Letter: T
Question
The treasurer for Pittsburgh Iron Works wishes to use financial futures to hedge her interest rate exposure. She will sell five Treasury futures contracts at $118,000 per contract. It is July and the contracts must be closed out in December of this year. Long-term interest rates are currently 10.30 percent. If they increase to 12.50 percent, assume the value of the contracts will go down by 10 percent. Also if interest rates do increase by 2.2 percent, assume the firm will have additional interest expense on its business loans and other commitments of $72,000. This expense, of course, will be separate from the futures contracts.
What will be the profit or loss on the futures contract if interest rates go to 12.50 percent by December when the contract is closed out? (Input the amount as a positive value.)
After considering the hedging, what is the net cost to the firm of the increased interest expense of $72,000?
What percent of this $72,000 cost did the treasurer effectively hedge away? (Input your answer as a percent rounded to 2 decimal places.)
Indicate whether there would be a profit or loss on the futures contracts if interest rates went down.
The treasurer for Pittsburgh Iron Works wishes to use financial futures to hedge her interest rate exposure. She will sell five Treasury futures contracts at $118,000 per contract. It is July and the contracts must be closed out in December of this year. Long-term interest rates are currently 10.30 percent. If they increase to 12.50 percent, assume the value of the contracts will go down by 10 percent. Also if interest rates do increase by 2.2 percent, assume the firm will have additional interest expense on its business loans and other commitments of $72,000. This expense, of course, will be separate from the futures contracts.
Explanation / Answer
Answer:a
Answer:b-1
Answer:b-2
The net cost is 18.06 percent. This means 81.94 percent of the increased interest cost was hedged away.
Answer:c If interest rates went down, there would be a loss on the futures contracts. The lower interest rates would lead to higher bond prices and a purchase price that exceeded the original sales price.
Sale Price, December Teasury bond contract (Sale takes place in July) 118000 Purchase price, December Treasury bond contract (10% price decline) .90*118000 106200 Gain per contract 11800 Number of contracts 5 Profit on futures contracts 59000Related Questions
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