Question 1

Your Company is expecting to borrow RM34,000,000. It expects to make a full repayment of the borrowed amount in 6 months time. Assume it is 1 December 2019 today. Your company can borrow funds at KLIBOR plus 70 basis points. KLIBOR is currently 3.6%, but your company expects that interest rates may increase by as much as 80 basis points in 6 months time.

The following information and quotes from an appropriate exchange are provided on KLIBOR-based RM futures and options.

Three-month RM June futures are currently quoted at 95.84. The contract size is RM1,000,000, the tick size is 0.01% and the tick value is RM25.

Options on three-month RM futures, RM1,000,000 contract, tick size 0.01% and tick value RM25. Option premiums are in annual %.

June Calls Strike price June Puts

0.541 95.50 0.04

0.223 96.00 0.508

Assumptions

It can be assumed that settlement for both the futures and options contracts is at the end of the month; and that if the options are in-the-money, they will exercised at the end of the hedge instead of being sold.

Required:

Based on the hedging choices available to your company and the assumptions given above, recommend a hedging strategy for the RM34 million borrowing. (15 marks)