Elliott Company sold one T-Bill futures contract when the quoted price was 93.25

Question

Elliott Company sold one T-Bill futures contract when the quoted price was 93.25. When the position was closed out, the price of the T-Bill futures contract was 94.12. A.) Did interest rates increase or decrease? How do you know? B.) What was Elliott’s profit or loss from this contract (ignoring transaction costs)? C.) Assume that Elliott was speculating, did the company benefit from (or was it hurt by) this transaction? Explain (very) briefly. D.) Assume that Elliott was using this contract to hedge. Did Elliott benefit from, or was it hurt by, this transaction? Explain (very) briefly.

Explanation / Answer

A) Price of a bond is sum of present values of all future values discounted at interest rates.

Price has increased which implied present value has increased. So discount rate used to get PC's has decreased.

So interest rates in the market have decreased.

B) Loss on this transaction = 94.12 - 93.25 = 0.87

C) If Elliott sold the futures contract, he was speculating the price to go down, where here the price has increased. Since the speculation is not gone the way the company was anticipating it has hurt by the decision.

Speculations are made in order to make profits and there is no other underline strategy behind it.

D) If Elliott sold the futures contract for hedging purpose, that implies it has anticipated that interest rates will go down in future and so to minimize risk, enter into this kind of contract. Since the anticipation of the company is gone the way the company was anticipating, it has benefited by the decision.

Hedging is made in order to reduce risks of underlining assets.

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