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Dudley Savings Bank wishes to take a position in Treasury bond futures contracts, which currently have a quote of 110 − 100. Dudley Savings thinks interest rates will go down over the period of investment. The face value of the bond underlying the futures contract is $100,000. a. Should the bank go long or short on the futures contracts? b. Given your answer to part (a), calculate the net profit to Dudley Savings Bank if the price of the futures contracts increases to 110 − 250.

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Answer:

a. Long

b. $375.00

Explanation:

a. If interest rates decrease over the period of investment, Treasury bond prices will increase. Thus, Dudley Savings Bank should take a long position in the futures contracts on the Treasury bonds. As T-bond prices go up, so will T-bond futures prices.

b. Given a long position:

Net profit = Sale price of futures − Purchase price of futures

= $107,687.50 − $107,312.50 = $375.00

Purchase price of futures = 107 − 100 = 107 10/32% × $100,000 = $107,312.50

Sale price of futures = 107 − 220 = 107 22/32% × $100,000 = $107,687.50

Explanation:

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