Question
Company A has a new project that will require an investment of $500,000 at t=3. You will fund this project in two ways. The company
Company A has a new project that will require an investment of $500,000 at t=3. You will fund this project in two ways. The company has a current project that will produce $100,000 one year from today. At t=1, the company will deposit the money from its current project for two years (it will buy a two-year bond worth $100,000). It will use the proceeds from this bond (which matures at t=3) to partially fund the new project. It will raise the remaining balance needed by issuing a one year bond at t=3. Your manager has asked you to hedge all interest rate risk. (interest rates for different maturities (1yr, 2, 3, 4, 5) are (1.0%, 2.8, 4.5, 5.5, 4.0) respectively.)
a. What is the cash flow at t=3 from the FRA associated with the two-year bond?
b. What must be the value of the one-year bond issued at t=3?
c. What is the cash flow at t=4 from the FRA associated with the one-year bond?
d. In total, what amount will the company need at t=4 in order to fulfill its obligations?
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