Question

In: Finance

Hanig Bottle Company wants to borrow $20M three months from today for a 9 month period....

Hanig Bottle Company wants to borrow $20M three months from today for a 9 month period. Hanig wants to protect against interest rate risk by entering into a 3x9 forward rate agreement (FRA) at 3.25%. In 3 months, the interest rates are 2.5%.

Hanig receives $112,500 from the FRA.

Hanig allows the FRA to expire unused.

Hanig receives $150,000 from the FRA

Hanig pays $112,500 on the FRA.

Solutions

Expert Solution

Forward Rate Agreement Entered by  Hanig Bottle Company to protect Against Interest Rate Risk.

If the interest rate rises its cash outflow due to the higher interest rates will be increased. If the interest rate falls its cash outflow will fall.

To prevent cash flow from fluctuation Hanig Bottle Company will enter into FRA. Where interest rate will be locked at the agreed interest rate Here it is 3.25%. So When the interest rate when increases FRA dealer will pay Hanig Bottle Company notional difference amount and when the interest rate when decreases Hanig Bottle Company will pay  FRA dealer notional difference amount. Resulting Net cash flow at any given scenario will be constant for Hanig Bottle Company.

Here interest Rate falls from 3.25% to 2.50% So, Hanig Bottle Company Will pay FRA dealer.

Amount Will Pay  

A = P * Idiff * Time

Here

P = 20 Million = 20* 1000000

Idiff = 3.25% - 2.50% = 0.75%

Time = 09 Months = 09/ 12 Years = 0.75 Years

Amount Will Pay  

A = 20* 1000000 * 0.75% * 0.75 = 0.1125 *  1000,000 = 112, 500

Hanig Bottle Company will Pay FRA Dealer  $ 112, 500 (Ans)


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