Prudence Bank is a regular borrower in the interbank market. On the 9th of August 2023, the head of the Global Markets operations makes the decision to hedge the bank's interest cost on a three-month Eurodollar issuance of US$30 million, which is planned for November 2023. On 9 August, the bank could issue US$30 million in three-month Eurodollars at 4.61%. The corresponding futures rates for the three-month Eurodollar futures contracts are 4.83% (December 2023), 5.01% (March 2024), and 5.38% (June 2024).REQUIRED:A.What is the bank’s specific cash market risk that it should be concerned with on 9 August 2023? B.Should the bank buy or sell Eurodollar futures to hedge its borrowing costs? Which Eurodollar futures contract should the bank use? Explain why it is best. C.Assume that the bank takes the futures position that you recommended above at the rate available on 9 August 2023. On 6 November 2023, the bank issues US$30 million in Eurodollars at 6.25%. Coincidently, it closes out (reverses) its futures position when the futures rate on the contract you chose equals 6.33%. Calculate the profit or loss on the futures trades, the opportunity gain or loss in the cash market, and the effective return or cost to the bank on its Eurodollar issue
Prudence Bank is a regular borrower in the interbank market. On the 9th of August 2023, the head of the Global Markets operations makes the decision to hedge the bank's interest cost on a three-month Eurodollar issuance of US$30 million, which is planned for November 2023. On 9 August, the bank could issue US$30 million in three-month Eurodollars at 4.61%. The corresponding futures rates for the three-month Eurodollar futures contracts are 4.83% (December 2023), 5.01% (March 2024), and 5.38% (June 2024).
REQUIRED:
A.
What is the bank’s specific cash market risk that it should be concerned with on 9 August 2023?
B.
Should the bank buy or sell Eurodollar futures to hedge its borrowing costs? Which Eurodollar futures contract should the bank use? Explain why it is best.
C.
Assume that the bank takes the futures position that you recommended above at the rate available on 9 August 2023. On 6 November 2023, the bank issues US$30 million in Eurodollars at 6.25%. Coincidently, it closes out (reverses) its futures position when the futures rate on the contract you chose equals 6.33%. Calculate the profit or loss on the futures trades, the opportunity gain or loss in the cash market, and the effective return or cost to the bank on its Eurodollar issue
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