- 10 Marks
FM – L2 – Q99 – Hedging with futures
Recommend futures/options to hedge interest rate risk for a company's loan, tender bid, and deposit scenarios.
Question
Three-month euro interest rate futures are available on a derivative exchange. Available delivery months for the future are March, June, September, and December, and the contract size for the future is €1,000,000.
Provide a justified recommendation for the most appropriate futures or options transaction in order to hedge interest rate risk in the following situations:
a) A company, Starlight Ltd, is taking out a loan of €3 million for 6 months from June to fund working capital for a new venture.
b) A company, BrightFuture Ltd, has tendered for a large government project. If it is the successful bidder, it will need to borrow €12 million for three months starting in September to cover initial costs.
c) It is June, a company, Horizon Enterprises, has €7 million on deposit with a bank for one year at 3-month money market rates. The company has become concerned about the possibility that money market interest rates may fall dramatically.
Find Related Questions by Tags, levels, etc.
