Question

In: Finance

Assume it is now 1 January: ABC Ltd will be arranging a six-month, $10M loan at...

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:

  1. 14 r
  2. 4
  3. Any other methods recommended to hedge the interest rate risk of ABC Ltd?

Solutions

Expert Solution

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

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