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ACCA AFM · Guided practice (Show me how)

Chapter 20: Interest Rate Risk Management (1)

Interest rate futures: hedging a future loan

Interest rate futures are quoted as 100 minus the annual rate in percentage points. All contracts cover three months of interest.

(a) It is 3 October and X plc will borrow $6 million for 6 months starting on 1 January. Rates today are 8% a year and January futures are 92.00. On 1 January rates are 10% and the futures price is 90.00.

(b) It is 1 November. Barbara plc will borrow $40,000,000 for 6 months from 1 January, paying the bank reference rate plus 1%. The reference rate today is 6%. Futures ($1,000,000 contracts) are January 93.50, February 93.40, March 93.35, expiring at the end of each named month. There are 3 months to January expiry and 1 month will remain when borrowing starts. On 1 January the reference rate is 9%. Assume the basis falls linearly, round the unexpired basis and estimated futures prices to two decimals before using them, and use whole dollars for loan interest.

  1. (a) The basic futures hedge

    Calculate the futures hedge and the outcome for X plc's six-month loan from 1 January.

  2. (b) Set up Barbara's hedge

    Calculate current loan interest and identify the futures hedge for Barbara's six-month loan from 1 January.

  3. (b) The futures price on 1 January

    Calculate the estimated futures price on 1 January when the loan starts.

  4. (b) The outcome and the effective rate

    Calculate the hedged net cost and effective annual borrowing rate for the six-month loan from 1 January.

Opening this exercise…