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FM – L2 – Q101 – Hedging with options

Calculate min net interest rate cost for a company borrowing $5m using options with a strike price of 94.50.

Question

It is May and a company intends to borrow $5m for 3 months commencing in September. Options are available on 3 month Canadian interest rate futures with a strike price of 94.50 and are quoted as follows:

Expiry month	Calls	Puts
June	0.10	0.31
September	0.46	0.67
December	0.63	0.84

The contract size of the 3-month Canadian interest rate future is $1 million.
Required
Calculate the minimum net interest rate cost for the company if it hedges using options with a strike price of 94.50.

Answer

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Tags: Borrowing, Currency Risk, Effective interest rate, Financial Risk Management, Futures, Hedging, Interest rate options, Options pricing, SOFRA, Treasury management
Level: Level 2

Topic: Hedging with options

FM – L2 – Q100 – Hedging with futures, Hedging with options

Firestone Ltd plans to borrow $5M and hedge interest rate risk using futures and options, calculating effective borrowing rates.

Question

Firestone Ltd, a Nigerian company, needs to borrow in US dollars to fund its US operations, but the chief financial officer is concerned that interest rates may be volatile given the current US political and economic environment.
It is now March and Firestone intends to borrow $5 million for a period of three months commencing in September.
Futures and options quotes for 3-month US secured overnight financing rate (SOFRA) are given below. Assume that Firestone can borrow at the three-month SOFRA rate.

3 month SOFRA futures price – contract size = $1,000,000

June	September
93.55	93.28

Traded options on 3-month SOFRA futures – contract size = $1,000,000 (premiums quoted are annual rates)

Strike	June (Calls)	September (Calls)	June (Puts)	September (Puts)
93.25	0.437	0.543	0.083	0.187
93.50	0.276	0.387	0.168	0.282
93.75	0.163	0.263	0.302	0.407

Required:
a) Discuss the relevant considerations to be considered when deciding between futures and options to hedge the company’s interest rate risk. (5 marks)
b) Assume that in September 3 month SOFRA is 7% and at that point in time September futures are quoted at 93.96.

Calculate the effective borrowing rate using a futures hedge
Calculate the effective borrowing rate when hedging with options using each of the three available strike prices

Answer

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Tags: Borrowing, Currency Risk, Effective borrowing rate, Financial Risk Management, Futures, Hedging Strategies, Interest rate hedging, Options, SOFRA, Treasury management
Level: Level 2

Topic: Futures and hedging with futures

MA – L2 – Q72 – Performance Analysis

Analyze Nexus Enterprises' financial performance using ratios and metrics for Years 1, 3, and 4 (forecast).

Question

The financial performance of Nexus Enterprises is summarised below. ‘Now’ is the end of Year 3.

	Year 1	Year 3	Year 4 (forecast)
Cost of sales/Sales	63%	70%	70%
Marketing costs/sales	9%	6%	5%
Distribution costs/sales	13%	8%	6%
Administration costs/sales	2%	2%	2%
Interest charges/Sales	0%	4%	8%
Operating profit/sales	13%	10%	9%
Loans/Sales revenue	0%	50%	67%
Inventory/Sales	10%	14%	18%
Sales/Non-current assets	4.7 times	1.9 times	1.2 times
Average sales per employee	600,000	1,032,000	686,000,000
Average sales per product	281,000	185,000	234,000
Average sales per supplier	750,000	726,000	651,000

Required:
Use this information to evaluate the financial performance of Nexus Enterprises.

Answer

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Tags: Borrowing, Cost Management, Employee Productivity, Financial Ratios, Inventory Management, Non-current Assets, Operating Profit, Performance Analysis, Profitability, Supplier Management
Level: Level 2

Topic: Performance Analysis

Tag (SQ): Borrowing

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FM – L2 – Q101 – Hedging with options

Calculate min net interest rate cost for a company borrowing $5m using options with a strike price of 94.50.

FM – L2 – Q100 – Hedging with futures, Hedging with options

Firestone Ltd plans to borrow $5M and hedge interest rate risk using futures and options, calculating effective borrowing rates.

MA – L2 – Q72 – Performance Analysis

Analyze Nexus Enterprises' financial performance using ratios and metrics for Years 1, 3, and 4 (forecast).

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FM – L2 – Q101 – Hedging with options

Calculate min net interest rate cost for a company borrowing $5m using options with a strike price of 94.50.

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FM – L2 – Q100 – Hedging with futures, Hedging with options

Firestone Ltd plans to borrow $5M and hedge interest rate risk using futures and options, calculating effective borrowing rates.

You're reporting an error for "FM – L2 – Q100 – Hedging with futures, Hedging with options"

MA – L2 – Q72 – Performance Analysis

Analyze Nexus Enterprises' financial performance using ratios and metrics for Years 1, 3, and 4 (forecast).

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