Note: a) In both cases, Nero Co`s effective interest rate for the loan is 5%, the rate agreed by the FRA is USD 2 million x 5/100 x 3/12 USD – 25,000 USD. b) Partly iii) If interest rates have fallen, Nero Co would undoubtedly wish it had not entered the FRA, so it would not have to pay $5,000 to Helpy Bank. However, the FRA`s objective is to ensure security and not to guarantee the lowest possible cost of credit to Nero Co, so that $5,000 must be paid to Helpy Bank. The interest rate derivatives that are discussed are: the basis can be adopted to reduce to zero to the duration of the contract with a constant interest rate, based on monthly time intervals, but in the second part, where the price of 0.9% of 4.09% shows that 20 bases have been reduced (rate used to 4.09%-0.9-3.19%) Wouldn`t we pay a premium to the bank for futures contracts, such as for the guarantee of interest rates? So what`s the difference between the two coverage options? This assumes that the bank acts reliably with Wardegul Co and there is no risk of insolvency. While Wardegul Co believes that the current economic uncertainty could lead to the bank`s risk of insolvency, the choice is between futures and options, which will be guaranteed by the exchange. Here too, option 95.25 can be ruled out because it gives a much worse result if interest rates fall to 3.6%. In both scenarios, futures perform slightly better than option 94.25, but the difference is small. If Wardegul Co thinks there is a possibility that interest rates will exceed 5.41 per cent, to the point where option 94.25 would not be exercised, it may choose this option instead of the future. Think about it, and it will make sense: say that a futures contract allows borrowers and lenders to pay or receive interest of 5%, which is the current rate available on the market. Now imagine that the market interest rate rises to 6%. The 5% futures contract has become less attractive because depositors can earn 6% at the market rate, but only 5% below the futures contract. The price of the futures contract must go down.
It would have been wiser to align the term of the credit with the duration of the credit so that the company could benefit from lower interest rates if they occur. If one of the options for both interest rates is exercised, as the 94.25 is here, the calculations should give the same result. Since these are CALL options, call options, choose the lower price and so: If the exercise price is below the expected price futures, EXERCISE – If the exercise price is HIGHER as the expected futures price, NOT REFERENCE To P4 acca December 2013 Qn 2 (Awan Co). in the FRA, when the rate of 4.09% increases by 0.9%, the base of 20 has been reduced (rate used in Soln is 4.79% – 4.09%-0.9%-0.2%) When rates go down, the price of futures will go up, say, to 97.