Part A.

As part of its future liability financing strategy, your employer seeks to borrow $25 million in the next 90 days and has contracted to borrow at 90-day London Interbank Offer rate (LIBOR) of 4.75% plus 75 basis points. The lending bank will charge a commitment fee (or compensating balance) of $75,000 today in order to secure this forward loan contract. This loan is due to paid back in full in 6 months (i.e., 180 days).

As part of the risk management group of your firm, evaluate the strategic risk of your firms future financing plan and justify your analysis. Assume LIBOR could increase to 10% or decrease to 2% (with increments of 50 basis points) when your firm take out the loan, that is, 90 days from now.

Part B.

Now suppose your firm is expecting to receive $25 million (i.e., accounts receivables) in 90 days and its future asset investment strategy is to invest these expected funds. Your firm has contracted to invest its accounts receivables at 90-day LIBOR of 6.25% plus 150 basis points for the next 365 days. Prepare a presentation illustrating why it is important for your firm to manage its interest rate risk using a forward interest rate contract. Assume LIBOR could increase to 10% or decrease to 2% (with increments of 50 basis points) when your firm plans to invest its expected infusion of cash, that is, 90 days from now.