As an alternative to a nine-month, 10% fixed-rate loan for $10 million, the Zuber Beverage Company is considering a synthetic fixed-rate loan formed with a

$10 million floating-rate loan from First National Bank and a Eurodollar strip.

The floating-rate loan has a maturity of 270 days (.75 of a year), starts on December 20th, and the rate on the loan is set each quarter. The initial quarterly rate is equal to 9.5%/4, the other rates are set on 3/20 and 6/20 equal to one fourth of the annual LIBOR on those dates plus 100 basis points: (LIBOR % +

1%)/4. On December 20th, the Eurodollar futures contract expiring on 3/20 is trading at 91 (IMM index), the contract expiring on 6/20 is trading at 92, and the time separating each contract is .25/year.

a. Explain how Zuber could use the strip to lock in a fixed rate. Calculate the rate the Zuber Company could lock in with a floating-rate loan and Eurodollar futures strip.

b. Calculate and show in a table the company’s quarterly interest payments, futures profits, hedged interest payments (interest minus futures profit), and hedged rate for each period (12/20, 3/20, and 6/20) given the following rates:
LIBOR = 10% on 3/20 and LIBOR = 9% on 6/20.