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Is it correct that when hedging interest rate risk we need to multiply the total amount of Loan with the interest being charged on it to see whether how much we have to pay the bank annually?
For example: If we have taken 8 years Loan of $800,000 from the bank on an interest rate of 6%, then we need to multiply the total $800,000 with the 6% to get the annual interest of $48,000 (800,000 * 6%) which we need to pay annually for the rest of 8 years which will be in a total of $384,000 at the end of 8 years plus the principal amount of the loan of $800,000.
Is that correct sir?
Although the figures in your example have been calculated correctly, this is not what we are looking at when looking at hedging interest rate risk. What we are looking at is short-term loans at fixed interest where the loan will start on a future date and by that date the interest being charged might be different from the interest rate being quoted as of today.
In Paper FM you cannot be asked calculation questions on hedging interest rate risk, but are expected to be aware of the methods available.
I do suggest that you watch my free lectures on this. The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.
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