A company wishes to use financial futures to hedge its interest rate exposure. The company will sell five Treasury futures contracts at $126,000 per contract. It is July and the contracts must be closed out in December of this year. Long-term interest rates are currently 14.30%. If they increase to 15.50%, assume the value of the contracts will go down by 15%. Also, if interest rates do increase by 1.20%, assume the firm will have additional interest expense on its business loans and other commitments of $99,000. This expense will be separate from the futures contracts.

1. What will be the profit or loss on the futures contract if interest rates increase to 15.50% by December when the contract is closed out?
2. (i) After considering the hedging, what is the net cost to the firm of the increased interest expense of $99,000?

(ii) What percent of this $99,000 cost did the company effectively hedge away?

3. Indicate whether there would be a profit or loss on the futures contracts if interest rates went down.