Reading 16 - EOC 3. Effective IR cost

CFA Level III Derivatives
#1

This is the question:

  • The CIO of a Canadian private equity company wants to lock in the interest on a three- month “bridge” loan his firm will take out in six months to complete an LBO deal. He buys the relevant interest rate futures contracts at 98.05. In six- months’ time, he initiates the loan at 2.70% and unwinds the hedge at 97.30. The effective interest rate on the loan is:
    • A 0.75%.
    • B 1.95%.
    • C 2.70%.

In the answer it says that he is making a gain on the futures contract? How is that possible, to me it seems as he buys it at 98.05 and sell it at a lower price of 97.30?

#2

Refer to CFA Level 3 errata at: https://www.cfainstitute.org/-/media/documents/support/programs/cfa/cfa-level-iii-errata.ashx

In practice problem 3 (print page 338), the second sentence should read: “He sells the
relevant interest rate…”

That explains why it was a gain.

#3

That explains it. thank you!

1 Like
#4

No problem

#5

I have a silly doubt…Why is he selling interest rate futures…