Question 2: (10 Marks)

The CEO is afraid interest rates will increase by 0.5% in the United Kingdom. The U.K. subsidiary has a current short term loan of 1,000,000 that expires 90 days from now, but it will have to borrow the same amount again after expiry for operational expenses that will be incurred. Calculate the expected outcome of a 90 day forward rate agreement entered into in the United Kingdom to hedge against the increase in interest rates on 1,000,000. The current risk free United Kingdom rate is to be used as the agreed rate for the calculation. Also assume the settlement rate is the current risk free rate plus 0.5%. Advise the CEO whether HighTech should take a long or short position to hedge the risk of the increasing interest rates.

Show your calculation by applying the correct formula in the space provided below: 6 marks