Explain how treasurer can hedge the risk through Eurodollar futures contract

FRM interest rate future

4. A treasurer of an American company in March realizes that it needs to raise $25 million zero-coupon bond in August for a period of 6 months. Zero-coupon bond of similar quality is currently yielding 4%, a cost, which the treasurer finds acceptabl(e) The treasurer is of the view that interest rate will rise before the company will issue the debt, hence will increase the cost of debt. So to hedge the interest rate risk the treasurer decided to hedge the risk using September Eurodollar futures contract. September 90-day Eurodollar futures contracts are currently trading at 96.25.

You are required to

• a.Explain how treasurer can hedge the risk through Eurodollar futures contract? How many futures contracts are required to hedge?
• b.If the September futures contract in August closes either at 95.75 or 96.80, calculate the cost of the bond to the company in each case.