solution

1. Suppose LIBOR3 is 7.93% and LIBOR6 is 8.11%. What is the forward forward rate for a LIBOR3 deposit to be placed in three months?

2. Suppose that Skandinaviska Ensilden Banken AB (SEB), the Swedish bank, funds itself with three-month Eurodollar time deposits at LIBOR. Assume that Alfa Laval AB (a Swedish manufacturing and engineering firm) comes to SEB seeking a one-year, fixedrate loan of $10 million, with interest to be paid quarterly. At the time of the loan disbursement, SEB raises three-month funds at 5.75% but has to roll over this funding in three successive quarters. If it does not lock in a funding rate and interest rates rise, the loan could prove to be unprofitable. The three quarterly refunding dates fall shortly before the next three Eurodollar futures-contract expirations in March, June, and September.

a. At the time the loan is made, the price of each contract is 94.12, 93.95, and 93.80. Show how SEB can use Eurodollar futures contracts to lock in its cost of funds for the year. What is SEB’s hedged cost of funds for the year?

b. Suppose that the settlement prices of the March, June, and September contracts are, respectively, 92.98, 92.80, and 92.66. What would have been SEB’s unhedged cost of funding the loan to Alfa Laval?