It is now April 1, and you are considering investing in 90 day bank bills in two months time (or 60 days). That is, on June 1 you intend to purchase bank bills with a face value of $2,000,000 at maturity.

You are concerned interest rates will fall over the next two months and you wish to hedge your interest rate risk using FRA contracts. For the purpose only of deciding on the appropriate FRA contract assume 1 month is equivalent to 30 days.

Also assume there are 365 days in a year.

Current FRA quotes are:

FRA Contract	Contract rate (p.a.)
1 x 3	5.50%
1 x 4	6.00%
2 x 4	6.25%
2 x 5	6.50%
4 x 6	6.60%

The rates quoted in the table above are simple rates.

The FRAs follows the standard Australasian terms (NOT the US settlement terms).

Required:

(a) To fully hedge your interest rate risk what FRA would you use? Also state if you should short or long the FRA contracts.

(b) Suppose 15 days after the initiation (assume t=15 now), the 45-day interest rate is 5.5% p.a. and the 135-day interest rate is 5.7% p.a. (both are continuously compounded).

i. Find the "new" FRA price on a 90-day loan issued 45 days from today and record your answer to 2 decimal places in percentage i.e. x.xx%.

ii. Disregard your answer to part (i) above. Assume the "new" FRA price on a 90-day bank bills issued 45 days from today is 5.80% p.a., as a simple rate, what is the fair value of the FRA to you today (i.e. at t=15)?