This is a question in CFA Level 3 derivatives curriculum. I want to ask one simple thing. Here, in this question the Canadian Private equity firm should be worried about Interest rate rising and therefore, they should sell Eurodollar future. Why have they bought? In the solution also, they have bought at a higher price and sold at a lower price and they are showing it as a gain.
- 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:
- 0.75%.
- 1.95%.
- 2.70%.
So, yes the language here is confusing. When the say they have bought the relevant interest rate futures contracts, what they mean actually is they bought the yield that is quoted to lock in the interest rate.
But since eurodollar futures are quoted as 100-3mLibor , it actually means you sell the future and not buy it.
Best way to understand these questions is to think logically what the firm wants to do like in this case lock in interest rate and not get confused of what is bought or sold.