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#1-Stan has sold a futures contract on Treasury bills that specified a price of 97.42. When the settlement date arrived, Stan closed out his position by purchasing a Treasury bills futures contract for 98.39. Ignoring transaction costs, determine Stan’s profit or loss.

Question 2: Did Stan anticipate interest rates to increase or decrease when he sold his futures contract? What did he anticipate would happen to T-bill prices?

(B) Assume that American First Bank (AFB) has more rate-sensitive assets (in terms of dollars) than rate-sensitive liabilities.

Question 1: Would AFB be more likely to be adversely affected by an increase or a decrease in interest rates? Explain why.
Question 2: Should AFB purchase or sell interest rate futures contracts in order to hedge its exposure? Explain.
Question 3: Would a long hedge be more appropriate than a short hedge for AFB? Why or why not?

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Jarrod Robel
Jarrod RobelLv2
28 Sep 2019

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(B) Assume that American First Bank (AFB) has more rate-sensitive assets (in terms of dollars) than rate-sensitive liabilities.
: Would AFB be more likely to be adversely affected by an increase or a decrease in interest rates? Explain why. Hint: Your answer should be in terms of how AFB’s interest revenues and interest expenses will be affected given this scenario.
: Should AFB purchase or sell interest rate futures contracts in order to hedge its exposure? Explain.
: Would a long hedge be more appropriate than a short hedge for AFB? Why or why not?

1. Futures Contracts Describe the general charac- teristics of a futures contract. How does a clearinghouse facilitate the trading of financial futures contracts?

2. Futures Pricing How does the price of a financial futures contract change as the market price of the security it represents changes? Why?

3. Hedging with Futures Explain why some futures contracts may be more suitable than others for hedging exposure to interest rate risk.

4. Treasury Bond Futures Will speculators buy or sell Treasury bond futures contracts if they expect interest rates to increase? Explain

7. Hedging with Futures Assume a financial institution has more rate-sensitive assets than rate-sensitive liabilities. Would it be more likely to be adversely affected by an increase or a decrease in interest rates? Should it purchase or sell interest rate futures contracts in order to hedge its exposure?

8. Hedging with Futures Assume a financial institution has more rate-sensitive liabilities than rate- sensitive assets. Would it be more likely to be adversely affected by an increase or a decrease in interest rates.

Should it purchase or sell interest rate futures contracts in order to hedge its exposure?

9. Hedging Decision Why do some financial insti- tutions remain exposed to interest rate risk, even when they believe that the use of interest rate futures could reduce their exposure?

10. Long versus Short Hedge Explain the difference between a long hedge and a short hedge used by financial institutions. When is a long hedge more appropriate than a short hedge?

11. Impact of Futures Hedge Explain how the probability distribution of a financial institution’s returns is affected when it uses interest rate futures to hedge. What does this imply about its risk?

12. Cross-Hedging Describe the act of cross-hedging. What determines the effectiveness of a cross-hedge?

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.

a.

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.)

(Click to select)ProfitLoss on futures contracts $

b-1.

After considering the hedging, what is the net cost to the firm of the increased interest expense of $72,000?

Net cost $

b-2.

What percent of this $72,000 cost did the treasurer effectively hedge away? (Input your answer as a percent rounded to 2 decimal places.)

Percentage hedged away %

c.

Indicate whether there would be a profit or loss on the futures contracts if interest rates went down.
Loss
Profit

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