Interest Rate Futures

FM – May 2019 – L3 – Q6 – Interest Rate Risk Management

Evaluate the effect of using interest rate futures to hedge a loan and compare the total cost after hedging with an interest rate guarantee.

Question

You are the head of the treasury group of Top Flight Aviation (TFA), a Nigerian company. The company operates chartered international flights for the elites in the country.

It is now December 31, and TFA needs to borrow £60 million from a UK bank to finance a new air jet. The borrowing and the purchase will be in three months’ time, and the borrowing will be for a period of six months.

You have decided to hedge the relevant interest rate risk using interest rate futures. Your expectation is that interest rates will increase from 13% by 2% over the next three months.

In the month of March, the current price of Sterling 3-month futures is 87.25. The standard contract size is £500,000.

Required:

a. Set out calculations of the effect of using the futures market to hedge against movements in the interest rate if:
(i) Interest rates increase from 13% by 2% and the futures market price moves by 2%;
(ii) Interest rates increase from 13% by 2% and the futures market price moves by 1.75%;
(iii) Interest rates fall from 13% by 1.5% and the futures market price moves by 1.25%;

In each case, show the hedge efficiency. The time value of money, taxation, and margin requirements should be ignored.

b. Show, for the situations in (a) above, whether the total cost of the loan after hedging would have been lower with the futures hedge chosen by the treasurer or with an interest rate guarantee which the treasurer could have purchased at 13% for a premium of 0.25% of the size of the loan to be guaranteed.

The time value of money, taxation, and margin requirements should be ignored.

(Total: 15 Marks)

Answer

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Tags: Futures Contracts, Hedging, Interest Rate Futures, Loan financing
Level: Level 3

Topic: Interest Rate Risk Management

FM – May 2018 – L3 – SC – Q5 – Financial Risk Management

Use of forward rate agreements and interest rate management tools for borrowing concerns in Katangwa Limited.

Question

Katangwa Limited will need to borrow ₦50 million in three months’ time for a period of six months. The company is concerned that interest rates are expected to rise over the next few months.

Interest rates and forward rate agreements (FRAs) are currently quoted as follows:

Spot 5.75 – 5.50
3 – 6 FRA 5.82 – 5.59
3 – 9 FRA 5.94 – 5.64

Required:

a. Explain how a forward rate agreement (FRA) may be useful to the company. Illustrate this on the basis that interest rates: i. Rise to 6.50% ii. Fall to 4.50%

(8 Marks)

b. Compare the use of interest rate futures with FRA in this instance. (4 Marks)

c. Explain how interest rate guarantees or a short-term interest rate cap could be used. (3 Marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Financial risk management, Forward Rate Agreement, Interest Rate Futures, Interest Rate Risk, Short-term Interest Rate Cap
Level: Level 3

Topic: Financial Risk Management
Series: MAY 2018

FM – May 2019 – L3 – Q6 – Interest Rate Risk Management

Evaluate the effect of using interest rate futures to hedge a loan and compare the total cost after hedging with an interest rate guarantee.

Question

You are the head of the treasury group of Top Flight Aviation (TFA), a Nigerian company. The company operates chartered international flights for the elites in the country.

You have decided to hedge the relevant interest rate risk using interest rate futures. Your expectation is that interest rates will increase from 13% by 2% over the next three months.

In the month of March, the current price of Sterling 3-month futures is 87.25. The standard contract size is £500,000.

Required:

In each case, show the hedge efficiency. The time value of money, taxation, and margin requirements should be ignored.

The time value of money, taxation, and margin requirements should be ignored.

(Total: 15 Marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Futures Contracts, Hedging, Interest Rate Futures, Loan financing
Level: Level 3

Topic: Interest Rate Risk Management

FM – May 2018 – L3 – SC – Q5 – Financial Risk Management

Use of forward rate agreements and interest rate management tools for borrowing concerns in Katangwa Limited.

Question

Katangwa Limited will need to borrow ₦50 million in three months’ time for a period of six months. The company is concerned that interest rates are expected to rise over the next few months.

Interest rates and forward rate agreements (FRAs) are currently quoted as follows:

Spot 5.75 – 5.50
3 – 6 FRA 5.82 – 5.59
3 – 9 FRA 5.94 – 5.64

Required:

a. Explain how a forward rate agreement (FRA) may be useful to the company. Illustrate this on the basis that interest rates: i. Rise to 6.50% ii. Fall to 4.50%

(8 Marks)

b. Compare the use of interest rate futures with FRA in this instance. (4 Marks)

c. Explain how interest rate guarantees or a short-term interest rate cap could be used. (3 Marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Financial risk management, Forward Rate Agreement, Interest Rate Futures, Interest Rate Risk, Short-term Interest Rate Cap
Level: Level 3

Topic: Financial Risk Management
Series: MAY 2018

Question Tag: Interest Rate Futures

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FM – May 2019 – L3 – Q6 – Interest Rate Risk Management

Evaluate the effect of using interest rate futures to hedge a loan and compare the total cost after hedging with an interest rate guarantee.

Required:

FM – May 2018 – L3 – SC – Q5 – Financial Risk Management

Use of forward rate agreements and interest rate management tools for borrowing concerns in Katangwa Limited.

FM – May 2019 – L3 – Q6 – Interest Rate Risk Management

Evaluate the effect of using interest rate futures to hedge a loan and compare the total cost after hedging with an interest rate guarantee.

Required:

FM – May 2018 – L3 – SC – Q5 – Financial Risk Management

Use of forward rate agreements and interest rate management tools for borrowing concerns in Katangwa Limited.

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FM – May 2019 – L3 – Q6 – Interest Rate Risk Management

Evaluate the effect of using interest rate futures to hedge a loan and compare the total cost after hedging with an interest rate guarantee.

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FM – May 2018 – L3 – SC – Q5 – Financial Risk Management

Use of forward rate agreements and interest rate management tools for borrowing concerns in Katangwa Limited.

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FM – May 2019 – L3 – Q6 – Interest Rate Risk Management

Evaluate the effect of using interest rate futures to hedge a loan and compare the total cost after hedging with an interest rate guarantee.

Required:

You're reporting an error for "FM – May 2019 – L3 – Q6 – Interest Rate Risk Management"

FM – May 2018 – L3 – SC – Q5 – Financial Risk Management

Use of forward rate agreements and interest rate management tools for borrowing concerns in Katangwa Limited.

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