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The manager at the Country Bank is concerned about a decrease in interest rates as they are going to purchase a one million 5% 15-year

The manager at the Country Bank is concerned about a decrease in interest rates as they are going to purchase a one million 5% 15-year bonds in September. If interest rates decrease by 2%, the Country Bank will have to pay $66,000 more. Country Bank management therefore purchases ten December Treasury bond contracts at 100-150 (pts 32nds of 100%) in September. Interest rates drop by 2 percent and in December Country Bank management offsets its position by selling all the December Treasury bond contracts at 106-040 (pts 32nds of 100%).

  1. What is the dollar gain/loss to Country Bank from the combined cash and futures market operations described above?
  2. What is the respective basis at the initiation and termination of the hedge?
  3. Illustrate how the dollar return is related to the change in the basis from termination to initiation. Does the company incur a loss or gain due to change in basis? By how much?

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