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Question 8.P.5: In response to the above scenario, management sells 500, 90-...

In response to the above scenario, management sells 500, 90-day Eurodollar time deposits futures contracts trading at an index price of 98. Interest rates rise as anticipated and your financial firm offsets its position by buying 500 contracts at an index price of 96.98. What type of hedge is this? What before-tax profit or loss is realized from the futures position?

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Firm sells Eurodollar futures at (1,000,000*[1-((2/100)*90/360)] $995,000 (per contract)

Firm buys Eurodollar futures at (1,000,000*[(1-(3.02/100)*90/360]$992,450 (per contract)

Expected Before-tax Profit $ 2,550 (per contract)

And Total Profit would be 500*$2550 = $1,275,000

In this case the firm has employed a short hedge which partially offsets the higher borrowing costs outlined above.

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