Chapter 2 Practice Question Answers
1. Answer: C. A Eurodollar futures contract with a value of 96.50 implies a LIBOR rate of 3.50. If that LIBOR rate rises by 0.02, then it will be 3.52, and not 3.48. A LIBOR rate of 3.52 would also change the value of José’s account to 96.48, a drop of two basis points. Since each basis point is worth $25, José’s contract is reduced in value by $50, and thus $50 will be taken out of his margin account.
2. Answer: D. Since Eurodollar futures settled at a higher price and Andrew shorted the contract, his equity will decline. Thus, he will need to add margin to the account. His contract increased from 95.20 to 95.40, an additional 20 basis points. Since each basis point is equal to $25, the equity in his account declined by $500 (20 x $25). This reduces Andrew’s account balance from $820 to $320. Since Andrew dips below his maintenance margin, he must deposit enough cash to bring him up to his initial margin. It is not enough for Andrew to deposit $310 to bring his balance up to $630. Andrew must deposit an additional $500 to meet the original margin requirement.
3. Answer: A. When a customer shorts a contract and its value declines, the equity in his account has gone up, and he is not required to add margin to the contract.
4. Answer: A. This is a perfect hedge, without profit or loss. The LIBOR rate in mid-December is 2.75% (100 – 97.25). When City Bank closes its position in March, its yield has gone up by 10 basis points to 2.85%. When yields go up, the contract price goes down. Since City Bank shorted the contract at the higher contract price and bought at the lower price, it makes a $250 profit (10 basis points x $25 per bp). This exactly offsets the 10–basis point loss incurred on the loan by waiting until March to borrow the money.
5. Answer: C. The price of the 30-day federal funds futures contract is the market’s opinion of the average overnight federal funds rate for the del