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Hi,
I want to know how to estimate close out price, why choose that figure in step 5. And why the spot price is 94. And in step 6, how to caculate the cost of loan in spot market?
Thank you so much
The reason they have looked at a 1% increase and a 1% decrease is that the question says at the end of the first paragraph that there is equal likelihood of their being a 100 basis points rise of fall.
The current LIBOR is 6%, which is equivalent to a futures price of 100 – 6 = 94.
The profit or loss when the contract is closed out is calculated on the difference between the futures prices. You do not have to use ticks (I never do!) – it is the difference in the futures price /400 x the contract size. (The reason for the 400 is that you divide by 100 because it is a percentage, and you divide by 4 because they are always 3 month futures i,e, 1/4 of a year).
If you watch my lecture on interest rate futures you will see how they calculate the profit or loss in detail.
Thank you so much, mr. Moffat. It’s very helpful.
I have another question about this Q.
In the end of second paragraph, it said the company would like to keep the maximum borrowing rate at6.6%. Is that means if the answer is higher than 6.6%, we need adjust it to 6.6%?No – you can’t adjust it 🙂
What you are expected to do is to simply state whether or not they company would achieve its objective. If they end up with a maximum of more than 6.6% then they have not, if less than 6.6% then they have 🙂
You would get a mark for stating that correctly as applied to your answer, whether or not your calculations were correct.
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