Question
River Valley Bank will have a $ 4 million loan with a twelve-month maturity coming due in the near future April 2021. It will be
River Valley Bank will have a $ 4 million loan with a twelve-month maturity coming due in the near future April 2021. It will be renewed for another twelve months at that time. The bank is concerned that interest rates will fall by the time the loan renews and they will earn less interest on the loan than they are now. Current interest rates on loans of this type are 9 percent. Rates are expected to decrease to 8.5% when the loans come due. The index value on 90 day Euro CD futures is 98 ($98 per $100 face value).
(A) What type of hedge is called for in this situation?
(B) How many futures contracts (@ $1 million per contract) should the bank use?
(C) What is the expected loss in interest revenue on the loan?
(D) Assume at the time the loan is renewed the index value on Euro CDs increases to 99.6. Calculate the gain on the futures position by calculating the price (value) of the futures contracts today and at the time the loan is rolled over in January.
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