[kellyanbatchu]

Why did they times the difference n by 1/(1+(3.5%*4/12))

[kellyanbatchu]

Question

Assume that it is now 1 June. Your company expects to receive £7.1 million from a large
order in five months’ time. This will then be invested in high-quality commercial paper for a
period of four months, after that it will be used to pay part of the company’s dividend. The
company’s treasurer wishes to protect the short-term investment from adverse movements
in interest rates, by using futures or forward rate agreements (FRAs).
The current yield on high-quality commercial paper is LIBOR + 0.60%.
LIFFE £500,000 three month sterling futures. £12.50 tick size.
September 96.25
December 96.60
Futures contracts mature at the month end. LIBOR is currently 4%.
FRA prices (%)
4 v 5 3.85 – 3.80
4 v 9 3.58 – 3.53
5 v 9 3.50 – 3.45

Answer
FRA:
The FRA fixed rate is 3.45%. Actual LIBOR is 3.5%. The company will therefore have to
make a payment to the bank.

This will be: £7.1m (3.50% – 3.45%) × 4/12 ×1/ (3.5% 4 /12)

or £1,169.65

I am not understanding the solution I just did this: £7.1m (3.50% – 3.45%) × 4/12= 1183

[kellyanbatchu]

I used your suggested answer with the Lammer Question and got the correct answer. The method used in Lammer plc is confusing. Not understanding why they use the numerators 7 & 2

[kellyanbatchu]

I am looking at the answers but im just confused, here is another question and the related answer

Lammer plc is a UK-based company that regularly trades with companies in the USA.
Several large transactions are due in five months’ time. These are shown below. The
transactions are in ‘000’ units of the currencies shown.

Assume that it is now 1 June and that futures and options contracts mature at the
relevant month end.

Exports to: Imports from:
Company 1 $490 £150
Company 2 – $890
Company 3 £110 $750

Exchange rates: $US/£
Spot 1.9156–1.9210
3 months forward 1.9066–1.9120
1 year forward 1.8901–1.8945

Answer
Forward market hedge:
No five-month forward rate is given. The rate may be interpolated from the three-month
And one-year rates for buying dollars.

The estimated five-month forward rate is:

1.9066 x 7/9 + 1.8901×2/9 = 1.9029
1,150,000/1.9029= 604,341

I used the same approach as this for Polytot but did not get the same answer

[kellyanbatchu]

I am seeking some clarity in regards to how find a 4 month forward exchange rate when given a 3 mnth forward and a 1 year forward.

POLYTOT PLC
Assume that it is now 1 July. Polytot plc has received an export order valued at 675 million
pesos from a company in Grobbia, a country that has recently been accepted into the
World Trade Organisation, but that does not yet have a freely convertible currency.
The Grobbian company only has access to sufficient $US to pay for 60% of the goods, at the
official $US exchange rate. The balance would be payable in the local currency, the
Grobbian peso, for which there is no official foreign exchange market. Polytot is due to
receive payment in four months’ time and has been informed that an unofficial market in
Grobbian pesos exists in which the peso can be converted into pounds. The exchange rate
in this market is 15% worse for Polytot than the ‘official’ rate of exchange between the
peso and the pound.

Exchange rates:
$/£
Spot 1.5475–1.5510
3 months forward 1.5362–1.5398
1 year forward 1.5140–1.5178

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