Past Exam Dec 2013

Is it that if the question changed to Awan CO needs to hedge against a rise in the interest rate, then it will need to go short in the futures market? How it will change the calculation? For example, if interest rates increase by 0.9% to 4.99%, the calculation will be like below: Gain on the futures market = (0.9476 - 0.9455) x 2,0000,000 x 3/12 x 32 = 33,600?

laengjei: No. The March futures expire on 31 March. Today is 1 November, and so there are 5 months until the futures end. We will close the contract on the day the loan starts, which is 1 February and is therefore 3 months from now. So when we finish the futures deal there are two months unexpired. With regard to your second question, Again No. If you are borrowing money then you will always sell futures now and buy back later. If you are investing money (as in this question) then you will always buy futures now and sell later. It is irrelevant which way you expect interest rates to move - the whole point of using futures is that it fixes the final amount whether interest rates go up or down (subject to the problem of contract size and of the basis risk). With futures you are not trying to make an overall gain or loss - you are trying 'fix' the net receipt and therefore remove the risk. (My free lectures on this may be of some help to you)