Perus Co is a listed electronics company. Perus Co has recently appointed a new chief executive, who has a number of plans to expand the company. The chief executive also plans to look carefully at the costs of all departments in Perus Co's head office, including the centralised treasury department.

The first major investment which the chief executive will oversee is an investment in facilities to produce applications-specific components. To finance the planned investment, it is likely that Perus Co will have to borrow money. It is now 1 May. At present, it seems that Perus Co will need to borrow $84 million on 1 September, for a period of six months, though both the amount and the period of borrowing are subject to some uncertainty.

The treasurer plans to borrow the funds at a variable rate of LIBOR plus 50 basis points. LIBOR is currently 45% but is expected to rise by up to 06% between now and 1 September. Three-month traded September $ futures is 94.64.

Perus Co's treasurer also wants to consider using options on futures to hedge loans. Relevant information about options is as follows:

Options

The current price for three-month $ September futures, $2 million contract size is 9505. The price is quoted in basis points at 100 - annual % yield.

Options on three-month September $ futures, $2 million contract size, option premiums are in annual %

September calls, Strike price September puts are 0132 ,9525 and 0411 respectively.

It can be assumed that futures and options contracts are settled at the end of each month. Expected futures price at maturity is 94.81

Treasury staffing

Perus Co's new chief executive has made the following comments: 'I understand that the treasury department has a number of day-to-day responsibilities, including investing surplus funds for the short term liquidity management and hedging against currency and interest rates. However, these tasks could all be carried out by the junior, less experienced, members of the department. I do not see why the department needs to employ experienced, expensive staff, as it does not contribute to the strategic success of the company.'

Required:

(a) Identify the option to be used and calculate the results of hedging the $84 million using the options (showing the working for effective interest payment and number of options to be purchased for Perus Co. (12)

(b) Criticize the views of the chief executive about the work carried out by the treasury department and the staff required to work. (Relate to the ethics and the roles for treasury department)