Sizing Eurodollar Futures to Hedge a Commercial Paper Issue

Summary

The document explains how a treasurer can use Eurodollar futures to hedge the interest-rate exposure of a planned commercial paper issue. With the futures price implying an annual rate of eight percent, the answer converts that rate to a quarterly interest amount. A futures contract is treated as covering the interest on an initial borrowing of $980,000 that grows to $1 million over three months. The proposed hedge scales the amount to be financed by this contract value and doubles the count to reflect the paper’s six-month term.

The explanation is a simplified contract-sizing illustration, not a full hedge analysis. It assumes the stated rate and contract economics, and does not discuss changes in rates, timing mismatches, or basis risk between commercial paper and Eurodollar futures. The question’s quoted arithmetic appears to contain a typographical error in the denominator; the explanation identifies the intended contract value as $980,000.

Key ideas

• A futures quote of 92 corresponds to an implied annual rate of eight percent in the example.
• At two percent for a quarter, a $1 million repayment corresponds to a $980,000 initial amount.
• The suggested contract count scales the initial borrowing by the amount covered per contract and adjusts for the six-month exposure.
• The calculation illustrates rate exposure sizing but does not account for basis or timing risk.

Tags

# Interest Rate Futures Question from Hull, 8e


# Interest Rate Futures Question from Hull, 8e












There is this question 6.16 in Hull, 8e:

Suppose that it is February 20 and a treasurer realizes that on July 17 the company will have to issue \$5 million of commercial paper with a maturity of 180 days. If the paper were issued today, the company would realize \$4,820,000. (In other words, the company would receive \$4,820,000 for its paper and have to redeem it at $5,000,000 in 180 days’ time.) The September Eurodollar futures price is quoted as 92.00. How should the treasurer hedge the company’s exposure?

The solution says 9.84 contracts should be shorted to achieve the intended outcome and arrives at this number as follows:

4,820,000*2/980,0000

I don't get where this 980,000 comes from?

## Answer by Alex C (score 3, accepted)

https://quant.stackexchange.com/a/44761

The future is at 92, so the interest rate is 8% per year (!the good old days!) or 2% a quarter. Two percent interest on one million is 20,000. So one future covers the interest on 980,000 initial amount and allows you to repay 1,000,000 at maturity 3 months later.

You initially borrow 4,820,000 so you need 4,820,000/980,000 futures (for a three month loan). But it is a 6 month loan, so you need twice as much to pay the interest, i.e. 4,820,000*2/980,000

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.