Reference no: EM132462869

Problem - On January 1, 2021, a company contracts with a financial institution to roll over $1,000,000 face value of its notes payable every 91 days at the Treasury bill rate plus 1.4%. The current annual interest rate on U.S. Treasury bills is 1.2%. The yield on Treasury bills is highly correlated with the yield on the company's floating rate term loans. To hedge against a possible interest rate increase, on January 1, 2021 the company sells short $1,000,000 face value of 91-day Treasury bill (interest rate) futures at 98.8 (1.2% annual discount yield), and deposits $300 cash with the broker as margin. The futures qualify as a fair value hedge of the firm commitment to roll over the notes. At the end of the 91-day period (April 2, 2021), the futures price has risen to 99.2 (0.8% annual discount yield) and the company closes out its short position. It rolls over its notes at the agreed-upon rate of 2.2%. All income effects of the notes and the futures are reported in interest expense.

Required -

a. What rate does the company pay on the notes during the period January 1 through April 1, 2021?

b. Record the entries necessary on January 1 to record the futures position, and April 2, when the short position is closed out and the loan is rolled over.