Exercise
Answer the following questions.
1. A bank needs to borrow $20 million in federal funds in one month to meet its reserve requirements. It fears that interest rates may rise. It plans on using federal funds futures to hedge against interest rate risk. What should it do to be fully hedged?
A. Go long four federal funds futures contracts
B. Short four federal funds futures contracts
C. Go long 20 federal funds futures contracts
D. Short 20 federal funds futures contracts
2. It is February 1st, and a bank needs to purchase $40 million in T-bills in 90 days to meet its reserve requirements. It fears that interest rates may fall. It plans on using federal funds futures to hedge against interest rate risk. Assuming each federal funds contract is $5,000,000, what should it do to be fully hedged?
A. Go long 8 May federal funds futures contracts
B. Short 40 May federal funds futures contracts
C. Go long 40 May federal funds futures contracts
D. Short 8 May federal funds futures contracts
3. A bank needs to borrow $20 million in federal funds in one month to meet its reserve requirements. It fears that interest rates may rise. It plans on using federal funds futures to hedge against interest rate risk. It perfectly hedges its risk by shorting four federal funds contracts. But interest rates do not rise as expected. In fact, over the 30-day contract, interest rates go down by 20 basis points. How much did the bank gain or lose in total by placing the futures contract (including the change in the interest payments on money borrowed)?
A. $0
B. $3,333.60 gain
C.