Derivative Contracts
Explain how a market participant can use interest rate derivative contracts to hedge risks.
The explanation should include a description of what position the manager would take
(i.e., long or short; pay fixed or receive fixed); it is not sufficient simply to say that the
manager would use a contract.
(a) A lender is concerned with a decline in 3-month LIBOR. How can the lender hedge using
the Eurodollar futures contract?
(b) A borrower is concerned with an increase in 3-month LIBOR. How can the borrower
hedge using the Eurodollar futures contract?
(c) A portfolio manager is concerned with an increase in interest rates over the next quarter.
How can the manager use a Treasury bond futures contract to hedge?
(d) A portfolio manager is concerned with an increase in interest rates. How can the
manager use an interest rate swap contract to hedge?
(e) A portfolio manager is concerned with the credit risk of a corporate bond it holds
in its portfolio. How can the manager use a credit default swap to hedge the credit
risk instead of selling the corporate bond?