-A bank entered into a speculative position by buying an FRA (forward rate agreement). The agreed upon rate was 5% on LIBOR. The notional amount was $10,000,000. The agreement period is five months and the FRA period is three months. Assume each month has exactly 30 days. After one month the CEO of the bank wants to hedge this risk exposure by using Eurodollar futures.

(a) If interest rates decreased to 4.99% at the settlement day for the FRA would the bank have gained or lost money? If so, how much?

(b) Use your answer above (as its a one basis point move) to determine the hedge ratio of how many Eurodollar contracts need to be bought or sold. (Remember, Eurodollar futures pricesreflect inverse movements to interest rates. If rates go up, the futures price goes down. Also, remember that timing is very important. Today vs. the settlement day of FRA and futures vs. the end of the FRA period.)