The Glasgo Manufacturing Company forecasts a cash inflow of $20 million in two months from the sale of one of its assets. It is considering investing the cash in a First National Bank CD for 90 days. First National Bank’s jumbo CD pays a rate equal to the LIBOR. Currently such rates are yielding 6%.

Glasgo is concerned that short-term interest rates could decrease in the next two months and would like to lock in a rate now. As an alternative to hedging its investment with Eurodollar futures, First National suggests that Glasgo hedge with a forward rate agreement (FRA).

a. Define the terms of the FRA that would effectively hedge Glasgo’s future CD investment.

b. Show in a table the payoffs that Glasgo and First National would pay or receive at the maturity of the FRA given the following LIBORs: 5.5%, 5.75%, 6%, 6.25%, and 6.5%.

c. Show in a table Glasgo’s cash flows from investing the $20 million cash inflow plus or minus the FRA receipts or payments at possible LIBORs of 5.5%, 5.75%, 6%, 6.25%, and 6.5%. What is the hedged rate of return Glasgo would earn from its $20 million investment?