In: Finance
Assume it is now 1 January: ABC Ltd will be arranging a six-month, $10M loan at an interest rate based on six-months LIBOR to commence, in 6 month’s time, on July 1st. ABC Ltd wishes to hedge against an increase in interest on this loan by using an FRA. Hence on 1 January the company buys a six-twelve FRA from the bank at 8%.
Calculate the amount payable by the company or the bank if on the settlement date, which is 1 July, the six months LIBOR has moved to:
On Jan 1, ABC Ltd is arranging a loan for tenor 6 months @ 6M LIBOR payable on July 1 | |||||||||
To hedge the above ABC ltd entered into an FRA. Features of FRA are as follows | |||||||||
CASE a | CASE b | ||||||||
FRA | 8% | 8% | |||||||
R | 14% | 4% | |||||||
NP | $ 10,000,000.00 | $ 10,000,000.00 | |||||||
P | 180 | 180 | |||||||
Y | 360 | 360 | |||||||
Substituting the above values in the FRA formula, we will get | |||||||||
A | 300000 | -200000 | |||||||
B | 1.07 | 1.02 | |||||||
1/B | 0.934579439 | 0.980392157 | |||||||
FRAP | $ 280,373.83 | FRAP | $ (196,078.43) | ||||||
In case a ABC ltd will receive 280,373.83 $ and in case b ABC ltd will have to pay the bank 196,078.43$ | |||||||||
Other methods to hedge the interest rate risk ABC ltd can use are: Intrest rate swap, Caps, Floors, Collars |