Use the following information to answer questions 22 through 24.On October 1,the one-month LIBOR rate is 4.50 percent and the two month LIBOR rate is 5.00 percent.The November Fed funds futures is quoted at 94.50.The contract size is $5,000,000.
-Compute the dollar profit or loss from borrowing the present value of $5,000,000 at one month LIBOR and lending the same amount at two month LIBOR while simultaneously selling one November Fed funds futures contract.Assume that rates on November 1 were 7 percent,there is no basis risk,and the position is unwound on November 1.Select the closest answer.
A)-$3,150
B)$0
C)$3,150
D)$940
E)-$940

Question

Quizplus · Accepted Answer

The profit or loss from this strategy involves three components: the interest earned from lending at the two-month LIBOR rate, the interest paid for borrowing at the one-month LIBOR rate, and the gain or loss from the futures contract. 1. Borrowing at one-month LIBOR (4.50% annual rate) for one month on $5,000,000:$$ \text{Interest paid} = \$5,000,000 \times \frac{4.50\%}{12} = \$18,750 $$2. Lending at two-month LIBOR (5.00% annual rate) for one month (since we are unwinding after one month, we consider the rate for one month):$$ \text{Interest earned} = \$5,000,000 \times \frac{5.00\%}{12} = \$20,833.33 $$3. The futures contract is quoted as 94.50, which implies a rate of $100 - 94.50 = 5.50\%$. However, the actual rate on November 1 is 7%. The profit from the futures contract for a $5,000,000 contract size is:$$ \text{Profit from futures} = \$5,000,000 \times \frac{(5.50\% - 7.00\%)}{12} = -\$6,250 $$Adding these components together:$$ \$20,833.33 - \$18,750 - \$6,250 = -\$4,166.67 $$The closest answer provided is:A) -$3,150

Use the Following Information to Answer Questions 22 Through 24