Suppose in six months you plan to borrow $10,000,000 for three months and the rate at which you can borrow is LIBOR + 100bp.

a. What kind of FRA would you use to hedge your interest rate risk? More precisely, tell me the terms of the FRA (A x B) and whether you would buy or sell it. Assume the agreed rate is 3%. (4 points)

b. Assuming that the settlement rate in the FRA is LIBOR, that any interim cash flows can be invested at LIBOR, and that there are 90 days in the FRA period, given the data below, what is your profit or loss on the FRA and what is your effective borrowing cost stated in annual terms? (6 points) Today: LIBOR = 3% Three months later: LIBOR = 3.8% Six months later: LIBOR = 4.5% Nine months later: LIBOR = 4.0% 12 months later: LIBOR = 5.0%

c. Suppose you were to hedge with Eurodollar futures. Do you buy or sell the futures? How many contracts? When does the futures contract mature? If the futures price is 97 now and 95.5 at maturity, what is your profit or loss on the futures position? (5 points)