The treasurer for Thornton Pipe and Steel Company wishes to use financial

futures to hedge her interest rate exposure.

She will sell five Treasury futures

contracts at $105,000 per contract. It is July and the contracts must be closed

out in December of this year. Long-term interest rates are currently 7.4 percent.

If they increase to 8.5 percent, assume the value of the contracts will go down

by 10 percent. Also if interest rates do increase by 1.1 percent, assume the firm

will have additional interest expense on its business loans and other commitments

of $60,800. This expense, of course, will be separate from the futures

contracts.

a. What will be the profit or loss on the futures contract if interest rates go to

8.5 percent?

b. Explain why a profit or loss took place on the futures contracts.

c. After considering the hedging in part a, what is the net cost to the firm of the

increased interest expense of $60,800? What percent of this increased cost

did the treasurer effectively hedge away?

d. Indicate whether there would be a profit or loss on the futures contracts if

interest rates went down.