It is June 15th today. You plan to purchase risk-free zero coupon bonds with maturity on Oct 15th once you receive a bonus of $50 million on July 15th. July Eurodollar futures are currently trading at $98.60.

(1.1) What interest rate is implied by the Eurodollar futures price?

(1.2) What position should you take in the Eurodollar futures market to hedge the interest rate risk? Specify the direction and the quantity of your hedging position.

(1.3) For simplicity, assume that the futures contracts are settled on October 15 so profits in the futures positions are realized on October 15th.1 Suppose that, on July 15, the three-month LIBOR rate is 1.1% per annum. What is your (i) revenue on the spot market (principal plus interest revenue), (ii) profit from your futures position, and (iii) your total payoff (the sum of (i) and (ii)) as of October 15. Also calculate the annualized simple rate of return of the hedged portfolio. We ignore the time value between July 15 and October 15 and the effect of daily settlement in futures.

Answer rating: 100% (QA)

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