Answered step by step
Verified Expert Solution
Question
1 Approved Answer
A business plans to borrow approximately $40 million in short-term funding through the issue of commercial paper in three months' time. The business does not
A business plans to borrow approximately $40 million in short-term funding through the issue of commercial paper in three months' time. The business does not have a view on what is likely to happen to interest rates over the next three months, but it would be very satisfied if it could obtain its funding at the current yield. Using the following data: Today's data: i. current commercial paper yields 5.00 per cent per annum ii. 90-day bank-accepted bills futures contract 94.75. Data in three months: iii. commercial paper yields 6.00 per cent per annum iv. 90-day bank-accepted bills futures contract 94.25. Required: a) Show how 90-day bank-accepted bills futures contracts can be used to hedge the interest rate risk to which the business is exposed. Show the calculation and timing of all transactions and cash flows (ignore transaction costs and margin requirements). (10 marks) b) Explain why the final outcome may not be a perfect hedge. Provide a description of the risks that contribute to such an outcome. (6 marks) A business plans to borrow approximately $40 million in short-term funding through the issue of commercial paper in three months' time. The business does not have a view on what is likely to happen to interest rates over the next three months, but it would be very satisfied if it could obtain its funding at the current yield. Using the following data: Today's data: i. current commercial paper yields 5.00 per cent per annum ii. 90-day bank-accepted bills futures contract 94.75. Data in three months: iii. commercial paper yields 6.00 per cent per annum iv. 90-day bank-accepted bills futures contract 94.25. Required: a) Show how 90-day bank-accepted bills futures contracts can be used to hedge the interest rate risk to which the business is exposed. Show the calculation and timing of all transactions and cash flows (ignore transaction costs and margin requirements). (10 marks) b) Explain why the final outcome may not be a perfect hedge. Provide a description of the risks that contribute to such an outcome. (6 marks)
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started