Eurodollar futures contracts are traded on the CME with a size of $1 million. The initial margin is $540, and the maintenance margin is $400. You are the treasurer of a corporation, and we are at April 1. You know that you will have to pay cash for some goods worth $10 million that will be delivered on June 17. In turn, you will sell those goods with a profit, but you will not receive payment until September 17. Hence, you know that on June 17, you will have to borrow $10 million for three months. Today is April 1, and the current 3-month LIBOR is 6.25 percent. On the CME, the Eurodollar futures contract with June delivery is quoted at 93.280 percent. The contract expires on the second business day before the third Wednesday of the delivery month (expiration date: June 17).
a. What is the forward interest rate implicit in the Eurodollar futures quotation (93.280%) on April 1? Why is it higher than the current three-month Eurodollar rate (6.25%)?
b. What position would you take in futures contracts to lock in a three-month borrowing rate for June 17?
c. On June 17, the Eurodollar futures contract quotes at 91 percent, while the current Eurodollar rate in London is 9 percent. You unwind your position on that date. Describe the cash flows involved.