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Question - A bank has assets for $150 million and liabilities for $135 millions. The duration of the assets is 6 years and the duration of the liabilities is 4 years, the current interest rate is 10%. This company wants to hedge the balance sheet with euro-dollar futures contracts (contracts of $1,000,000), which currently have a price of $96 per $100 face value for the benchmark three-month Eurodollar CD underlying the contract. The current rate on three-month Eurodollar CDs is 4% and the duration of these contracts is 0.25 yrs.
1) Determine if the bank should sell or buy the contracts. Explain in detail why.
2) Assuming no basis risk, how many contracts are necessary to fully hedge the bank? Explain in detail your results.
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