Question 6 (11 marks) The corporate treasury team of ABC Ltd. is debating whether treasury management activities should or should not be centralized. The company's financial projections also show an expected cash deficit in four months' time of $18 million, which will last for a period of approximately five months. HIBOR is currently 8% per year, and ABC can borrow at HIBOR +1.5%. The treasury team believes that inflation pressure in USA will soon force the Federal Reserve to raise USA interest rate by 2% per year, which could lead to a similar rise in Hong Kong interest rates. In Hong Kong, the economy is still recovering from the financial turmoil and representatives of industry are calling for interest rates to be cut by 1%. The corporate treasury team believes that interest rate is more likely to rise than to fall. It is now 1 st of December HIBOR prices (1 December) Futures 3-month HIBOR $5,000,000 (100.00 minus the yield) One basis point equals to $125 December March 91.45 91.30 The treasury team also approaches a bank that can offer option contract on interest rate with the following specifications. The bank also suggests it can offer an interest rate collar to ABC. Options 3-month HIBOR $5,000,000 One basis point equals to $125 Exercise price 92.00 93.00 Calls March 0.50 0.30 Puts March 1.19 1.98 Required: a. Estimate the resulting interest cost of undertaking an interest rate collar hedge (buy put at 92.00 and sell call at 93.00) if HIBOR (1) increase by 2%, (2) decrease by 1%. (8 marks) Comment on whether ABC should use interest rate futures hedge or interest rate collar hedge. State your reasons. (3 marks) b. Question 6 (11 marks) The corporate treasury team of ABC Ltd. is debating whether treasury management activities should or should not be centralized. The company's financial projections also show an expected cash deficit in four months' time of $18 million, which will last for a period of approximately five months. HIBOR is currently 8% per year, and ABC can borrow at HIBOR +1.5%. The treasury team believes that inflation pressure in USA will soon force the Federal Reserve to raise USA interest rate by 2% per year, which could lead to a similar rise in Hong Kong interest rates. In Hong Kong, the economy is still recovering from the financial turmoil and representatives of industry are calling for interest rates to be cut by 1%. The corporate treasury team believes that interest rate is more likely to rise than to fall. It is now 1 st of December HIBOR prices (1 December) Futures 3-month HIBOR $5,000,000 (100.00 minus the yield) One basis point equals to $125 December March 91.45 91.30 The treasury team also approaches a bank that can offer option contract on interest rate with the following specifications. The bank also suggests it can offer an interest rate collar to ABC. Options 3-month HIBOR $5,000,000 One basis point equals to $125 Exercise price 92.00 93.00 Calls March 0.50 0.30 Puts March 1.19 1.98 Required: a. Estimate the resulting interest cost of undertaking an interest rate collar hedge (buy put at 92.00 and sell call at 93.00) if HIBOR (1) increase by 2%, (2) decrease by 1%. (8 marks) Comment on whether ABC should use interest rate futures hedge or interest rate collar hedge. State your reasons. (3 marks) b
