Suppose you have a loan of $10,000,000 outstanding, on which you will have to make a floating-rate interest payment on Tuesday, February 23d. The interest payment is determined by the interest rate implied by the Mar 16 Eurodollar futures contract as follows: $ interest payment = (QR)x(10,000,000)x(3/12) Thus, if the Eurodollar closed at Q = 98% (QR = 100 – 98% = 2%) on Tuesday, you would have to pay 0.02x10,000,000x(3/12) = $50,000. You fear that in the next several days the rate might rise. So you hedge yourself by trading the Mar 16 Eurodollar futures contract at the current level. Assume that you enter into the position at the close of day on Tuesday, February 16th.
In order to hedge yourself, will you buy the contract, or will you sell the contract? How many contracts will you trade?
What is your daily gain or loss in the contract (on Wednesday, Thursday, Friday, Monday, and Tuesday)?
Using the Tuesday, February 23d, settlement price, what is the interest payment that you have to make on your $10,000,000 loan?
What is the net cost to you, taking into account the gains/losses on your hedge (with the futures contract), plus the interest payment on the loan (ignore time value of money)?