D&R A3 3 - 7 Question 3. FRA Pricing, Valuation, Payoff, and Hedging Today is June 1. Sustainable Corporation has an obligation of $25 million coming due on August 1. The company is planning to borrow this amount on August 1 to fulfill its obligation, and plans to pay back the loan on December 1. The company’s borrowing rate is LIBOR + 125 basis points. The company’s bank presents it with the following LIBOR term structure: # days LIBOR 30 0.90% 60 1.00% 90 1.05% 120 1.10% 150 1.15% 180 1.18% 210 1.20% 240 1.21% For the calculation of interest, the bank assumes 30 days in a month, and 360 days in a year. Ms. Devro, the VP Finance of Sustainable, is worried that LIBOR will increase between June and August, thus increasing the company’s borrowing cost. She advises that the company enters into a forward rate agreement (FRA) with its bank to hedge its interest rate risk. She has asked you, the treasurer of the company, to present her with answers to the following questions: Should Sustainable hedge its interest rate risk with this FRA?
D&R A3
3 - 7
Question 3. FRA Pricing, Valuation, Payoff, and Hedging
Today is June 1. Sustainable Corporation has an obligation of $25 million coming due on August 1. The company is planning to borrow this amount on August 1 to fulfill its obligation, and plans to pay back the loan on December 1. The company’s borrowing rate is LIBOR + 125 basis points. The company’s bank presents it with the following LIBOR term structure:
|
# days |
LIBOR |
|
30 |
0.90% |
|
60 |
1.00% |
|
90 |
1.05% |
|
120 |
1.10% |
|
150 |
1.15% |
|
180 |
1.18% |
|
210 |
1.20% |
|
240 |
1.21% |
For the calculation of interest, the bank assumes 30 days in a month, and 360 days in a year.
Ms. Devro, the VP Finance of Sustainable, is worried that LIBOR will increase between June and August, thus increasing the company’s borrowing cost. She advises that the company enters into a forward rate agreement (FRA) with its bank to hedge its interest rate risk. She has asked you, the treasurer of the company, to present her with answers to the following questions:
- Should Sustainable hedge its interest rate risk with this FRA?
Trending now
This is a popular solution!
Step by step
Solved in 2 steps
