Final answer:
The student's question involves hedging interest rate risk using Eurodollar futures contracts. Without additional context, we cannot definitively say whether the treasurer should buy or sell futures. However, selling is commonly used to hedge against rising rates, which would lower the price of the paper.
Step-by-step explanation:
The question is related to hedging interest rate risk using Eurodollar futures contracts. When a treasurer wants to hedge interest rate risk for an issuance of commercial paper in the future, they can either buy or sell futures contracts depending on the anticipated direction of interest rate movements. The number of contracts needed for this is often calculated based on the face value of the bond or commercial paper and the current market value or price. Given the commercial paper has a face value of $10 million, the correct number of futures contracts to hedge interest rate risk would be determined by the expected change in value relative to interest rate fluctuations. The provided background information on bond risk and the impact of rising interest rates on bond prices illustrates the fundamental financial principle that as interest rates increase, existing bonds with lower rates become less attractive, therefore dropping in price. In the context of our main question, the decision between buying or selling Eurodollar futures would depend on whether you expect the interest rates to go up or down.
Since the question does not specify the direction of the expected interest rate movement, there is not enough information to provide a definitive action (buying or selling). However, typically, to hedge against rising interest rates (which cause the price of the paper to fall), a treasurer would sell futures contracts. On the other hand, if interest rates were expected to fall, thus raising the price of the paper, the treasurer would buy futures contracts. Without additional context from the problem regarding the expectation of interest rate movements, choosing between option (a) buying and option (b) selling Eurodollar futures contracts remains unclear. Option (c) suggests doubling the number of contracts, which is not connected to any provided calculation or context.