Bank A is to extend a one-year new loan of $20 million to one of its clients over the next week. However, the management expects a decrease in market interest rates. Currently loans can be allocated to customers at a promised interest rate of 4%, but management is fearful that loan interest rates may decrease by 1% at the time of allocating the new loan.

To offset the potential loss managers could purchase 10 contracts of 60-day Eurodollar futures trading at an MMI Index of 93.9, and then within next 60 days sell 10 contracts of 60-day Eurodollar futures trading at an MMI Index of 96.7. (6 marks)

1. Calculate the potential loss following a decrease in interest rates.

2. Calculate the potential gain following trading futures.

3. Calculate the overall return.

4. Explain what would happen if the expectation about interest rates does not come true and interest rates increase.