In May, your bank receives a request from a large company to borrow RM80 million for three months from August. Your bank has agreed to lend the money at KLIBOR plus 0.50%. However, your bank is worried about the risk of a drop in KLIBOR between May and August, so decides to hedge its risk exposure with KLIBOR futures.

Given the main contract specifications are as follows:

Underlying instrument ; Ringgit interbank time deposit in the Kuala Lumpur Wholesale Money Market with a three month maturity on a 360-day year.

Contract size ; RM1,000,000 Quoted in index terms (100.00 minus yield)

Contract months ; Quarterly cycle months of March, June, September and December up to 5 years ahead and 2 serial months.

Final settlement ; Cash settlement based on the cash settlement value.

a. Decide whether your bank should long or short the KLIBOR futures in order to hedge its interest rate exposure. Justify your answer.

b. Identify the contract month and the number of contracts required by your bank to hedge its interest rate risk exposure.

c. Assume the three-month KLIBOR rate has dropped to 2% in August, determine the profit made by your bank on its futures trading if the futures contract price is 96.25.