Reference no: EM132765376

Question - As a relationship officer for a money-center commercial bank, one of your corporate accounts has just approached you about a one-year loan for $1,000,000. The customer would pay a quarterly interest expense based on the prevailing level of LIBOR at the beginning of each three-month period. As is the bank's convention on all such loans, the amount of the interest payment would then be paid at the end of the quarterly cycle when the new rate for the next cycle is determined. You observe the following LIBOR yield curve in the cash market:

90-day LIBOR 4.60%

180-day LIBOR 4.75

270-day LIBOR 5.00

360-day LIBOR 5.30

Required -

a. If 90-day LIBOR rises to the levels "predicted" by the implied forward rates, what will the dollar level of the bank's interest receipt be at the end of each quarter during the one-year loan period?

b. If the bank wanted to hedge its exposure to failing LIBOR on this loan commitment, describe the sequence of transactions in the futures markets it could undertake.

c. Assuming the yields inferred from the Eurodollar futures contract prices for the next three settlement periods are equal to the implied forward rates, calculate the annuity value that would leave the bank indifferent between making the floating-rate loan and hedging it in the futures market and making a one-year fixed-rate loan. Express this annuity value in both dollar and annual (360-day) percentage terms.