A company borrows an amount of GBP1,000,000 for a term of 6 months at the interest rate of 4% per annum. The interest is to paid at the loan maturity. This borrowed amount in GBP is converted into USD to meet the company’s need of short-term financing in USD. The American company considers the use of currency futures contracts for hedging against the exchange rate risk. The current market information is as follows:

- Spot rate: 1.4250-1.4270USD/GBP

- GBP September Futures contracts are traded at 1.4360 USD/GBP

1.  At the beginning of the loan term, upon converting the borrowed GBP1,000,000. - to USD, how many USD does the American company get for meeting its need of short-term financing in USD?

2.  At the time of loan maturity (six months later), the spot rate is assumed to be 1.4550- 1.4560 USD/GBP. In case of not hedging, calculate the US dollar amount that the American company has to pay out to buy GBP for repayment of the loan (including interest payment) at the loan maturity (6 months later). Calculate the actual cost of the loan for this case (actual interest rate of the loan in terms of USD).

3.  In case of using GBP futures contracts for hedging, how can the American company use the currency futures contracts for hedging against the exchange rate risk? Indicate clearly the number of currency future contracts to be sold or bought by the American company now and six months later. Assume that the GBP futures contracts are traded in contract sizes of GBP62,500. - each.

4.  In case of using GBP futures contracts for hedging, calculate the US dollar amount that the American company has to pay out to buy GBP for repayment of the loan (including interest payment) at the loan maturity (6 months later) as well as the actual cost of the loan for this case (actual loan interest rate in terms of USD). At the time of loan maturity (six months later), assume the spot rate and the price of GBP September futures contracts are as follows:

• The spot rate: 1.4540-1.4560USD/GBP
• GBP September Futures contracts are traded at 1.4660 USD/GBP
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Answer rating: 100% (QA)

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