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8. Jacob Bower has a liability that: - has a principal balance of $100 million on June 30,2008 , Page 315 - accrues interest quarterly
8. Jacob Bower has a liability that: - has a principal balance of $100 million on June 30,2008 , Page 315 - accrues interest quarterly starting on June 30,2008 , - pays interest quarterly, - has a one-year term to maturity, and - calculates interest due based on 90-day LIBOR (the London Interbank Offered Rate). Bower wishes to hedge his remaining interest payments against changes in interest rates. Bower has correctly calculated that he needs to sell (short) 300 Eurodollar futures contracts to accomplish the hedge. He is considering the alternative hedging strategies outlined in the following table. Initial Position (6/30/08) in 90-Day LIBOR Eurodollar Contracts Contract Month Strategy A (contracts) Strategy B (contracts) September 2008 300 100 a. Explain why strategy B is a more effective hedge than strategy A when the yield curve undergoes an instantaneous nonparallel shift. b. Discuss an interest rate scenario in which strategy A would be superior to strategy B
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