Nile plc (Nile) is due to complete on the 15 million purchase of a new Head Office building in exactly 3 months time. It had been intending to fund the purchase with the proceeds from the sale of their existing Head Office, but due to lengthy legal issues with the sale, the cash proceeds from this are not expected for another 9 months. Nile therefore needs to borrow 15 million to finance the new Head Office purchase until the proceeds from the sale are received. The company will borrow the funds for a period of 6 months, starting in 3 months time.

Nile is concerned that interest rates may rise between now and when it needs to take out the loan. It is considering the use of a Forward Rate Agreement (FRA). FRAs currently available for a sum of 15 million are:

%

3-6 5.20 4.90

3-9 5.00 4.70

6-9 4.90 4.60

Required:

1. Describe the key features of a FRA and explain (without calculations) how Nile plc could attempt to minimise its interest rate risk by using a FRA.

(4 marks)

2. Assume that Nile plc did take out the appropriate FRA quoted above, and 3 months have now passed. The actual rate offered to Nile plc for the borrowing is 5.8%. Determine the cash flows associated with the FRA and compare the overall position to the position if the FRA had not been taken.

(6 marks)