Suppose that it is February 20 and a treasurer realizes that on July 17 the company will have to issue $5 million of commercial paper with a maturity of 90 days. If the paper were issued today, the company would realize $4,820,000. (In other words, the company would receive $4,820,000 for its paper and have to redeem it at $5,000,000 in 90 days' time.) The September Eurodollar futures price is quoted as 93.00.

2

a) How should the treasurer hedge the company's exposure?

b) Ignore marking to market prior to July 17. Suppose the annualized 3 month LIBOR rate on July 17 is 8%. Show the cash flows of the company on July 17 when it closes its Eurodollar futures contract.

c) How is the hedged borrowing cost in (2) comparing to the cost of issuing the commercial paper today, and the cost if borrowing can be done in September when the Eurodollar futures contracts expires?