A company will need to borrow $8$ million euros from the end of May. It is now

January. The company is concerned about the risk of a rise in the Euribor rate $($the

benchmark interest rate for the euro$)$ and it wishes to hedge its position with futures.

The current spot Euribor rate is $3\mathrm{.}50\%($for both three months and six months$)$ and

the current June Euribor futures price is the same, $96\mathrm{.}50.$

The value of $1$ tick for a Euribor futures contract is $25(1,000,000\backslash$times $0\mathrm{.}0001\backslash$times $3/12).$

Required

$($a$)$ How should the company hedge its interest rate exposure if it plans to borrow the

$8$ million euros for $(1)$ three months or $(2)$ six months? $(5$ marks$)$

$($b$)$ Suppose that in May when the company borrows the $8$ million euros, the threemonth and six$-$month spot Euribor rate is $4\mathrm{.}25\%$ and the June futures price is the

same, $95\mathrm{.}75(1004\mathrm{.}25).$ Calculate the effective annual interest rate that the

company has secured with its futures hedge if it borrows the $8$ million euros for

$(1)$ three months or $(2)$ six months. $(8$ marks$)$

PART B $(12$ MARKS$)$

It is now $31$ December $20$X$1$ and the corporate treasurer of ABC plc is concerned

about the volatility of interest rates. His company needs in three months$$ time to

borrow $5$ million for a six month period. Current interest rates are $14\%$ per year for

the type of loan ABC would use, and the treasurer does not wish to pay more than

this.

He is considering using:

$($i$)$ a forward rate agreement $($FRA$)$; or

$($iii$)$ interest rate futures; or

$($iii$)$ an interest rate guarantee $($short$-$term cap$).$

You are required to explain briefly how each of these three alternatives might be

useful to ABC plc$.$