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Dear Tutor,
In Example 6 and 7 of Chapter 23 (page 115) of your lecture notes, you explained that interest rates are always quoted per annum but we would sometimes be required to pro-rate for a shorter period.Why do you regard the interest rates in the aforementioned examples as “annual” even though the question says, “Current 3 month interest rates”??
Please compare your statement (“Current 3 month interest rates”) with this statement, “Three-month European borrowing rate” (extracted from Edwen Co (BPP Kit)), and explain the difference to me.
I’m so confused.
Please help.The Current 3 month interest rates indicates that the rate is applicable for a three-month period but is still based on an annualised rate.
So if a bank quotes a 5.2% rate for a three-month deposit, it means that the effective interest for that period is calculated as 5.2% per annum, which would be pro-rata for the three months, you take 5.2% and multiply by 3 months out of 12. …….. 5.2% x 3/12
Three-month European borrowing rate also refers to an annualised rate but specifies that it is the borrowing rate applicable for a three-month term instead.
The key difference lies in the context of application—one is for deposits and the other for borrowing, so both are fundamentally annual rates that are adjusted for the specific duration of the transaction.
So again it would be done the same way.
Take the annual rate and pro-rata it.“…so both are fundamentally annual rates that are adjusted for the specific duration of the transaction.”….. This is an excerpt from your reply.
I’m not sure of the correctness of your statement, Sir.
Similar wordings were used to solve a similar question in the BPP Kit, but it was NOT pro-rated in the BPP Kit because it already said, “3 months rates”I understand that one has to be for borrowing and the other, for depositing – that is not what I’m doubtful of.
Why is a similar wording used in BPP Kit but the treatments are different, Sir?A money market hedge is a tool that allows a business to lock in an exchange rate for a future transaction by borrowing or lending money in the foreign currency of the transaction. The hedge can be customised to specific dates and amounts.
When you are given a yearly rate then you pro rata it, when you are given a rate for a specific period of time you don’t.
So this is yearly rates
Need to pay $450,000 in 3 months
Exchange rate now: $1.7 – 1.7040:£
Forward rates $1.6902 – 1.6944:£
Deposit rates (3 months) UK 6% annual US 5% annual
Borrowing rates (3 months) UK 7.5% US 6.5% annualWhat is the £ cost of this using a money market hedge? £266,340
450000/1.0125= $444,444 needed.
(Deposit rate was arrived at as follows: 5%*3/12=0.0125%)
Convert $444,4444/1.7= £261,438
Borrow £: 261,438*1.01875 = £266,340
(7.5%*3/12=0.1875)Which questions are you referring to in the text and I can explain
We have several exam kits full of questions….. so I need an idea of which questions you are looking at
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