Hedging with Eurodollar futures. Jack Blair, the treasurer of the Simpson Corporation (SC), will need to borrow $1 million for three months starting December 20. He would like to hedge the borrowing rate with interest futures contracts. Searching for the right contract, he found that the Chicago Mercantile Exchange offers a 3-month Eurodollar futures contract with a settlement date on December 20, the same day he will have to borrow the $1 million. The contract currently trades at 97.00, which represents an interest rate of 3 percent per year. This rate is the London Interbank Offering Rate or LIBOR (see Chapter 11).

a. Assuming that SC can borrow at the LIBOR rate, what hedging strategy would you recommend to Jack?

b. Suppose that the LIBOR rate in three months is (1) 2.5 percent, (2) 3 percent, and (3) 3.5 percent. Under each of these scenarios, calculate the actual borrowing cost and borrowing rate for SC.