Reconsider Tree Row Bank in problem 16 but assume that the cost rate on the liabilities is 6 percent. On-balance-sheet rates are expected to increase by 100 basis points. Further, assume there is basis risk such that rates on 3-month Eurodollar CDs are expected to change by 0.10 times the rate change on assets and liabilities. That is,
a. How many contracts are necessary to fully hedge the bank?
b. Verify that the change in the futures position will offset the change in the cash balance sheet position for a change in market interest rates of plus 100 basis points and minus 50 basis points.
c. If the bank had hedged with Treasury bond futures contracts that had a market value of $95 per $100 of face value, a yield of 8.5295 percent, and a duration of 10.3725 years, how many futures contracts would have been necessary to fully hedge the balance sheet? Assume there is basis risk such that rates on T-bonds are expected to change by 0.75 times the rate change on assets and liabilities. That is, .