An FI issued $1 million of 1-year maturity floating rate commercial paper.The commercial paper is repriced every three months at the 91-day Treasury bill rate plus 2 percent.What is the FI's interest rate risk exposure and how can it use financial futures and options to hedge that risk exposure?
A)The FI can hedge its exposure to interest rate increases by selling financial futures.
B)The FI can hedge its exposure to interest rate decreases by selling financial futures.
C)The FI can hedge its exposure to interest rate increases by buying financial futures.
D)The FI can hedge its exposure to interest rate increases by buying call options.
E)The FI cannot hedge its exposure to interest rate increases or decreases using financial futures

Question

Quizplus · Accepted Answer

The FI is exposed to interest rate increases because the cost of its floating rate commercial paper will rise with increasing rates. Selling financial futures allows the FI to lock in current interest rates, thus hedging against future rate increases.

An FI Issued $1 Million of 1-Year Maturity Floating Rate