Assume that Star Industries while forecasting their annual cash flow found that they would have a shortfall of Rs 50 million after 6 months. The shortfall is expected to last for 6 months when the internal accruals would suffice and overcome the financial constraints. Assume that Commerce Bank (CB) are bankers to the firm and have been extending loan at MIBOR. The interest rates are expected to go up in the next 6 months. Following is the term structure of interest rates as on today:

Forward Bank is offering them an FRA (Forward Rate Agreement) arrangement against a reference rate of MIBOR for the period required to be covered.Assume 360 days in a year, 180 days in 6 months, ANNUAL 

COMPOUNDING and a bid ask spread of 20 basis points. You are required to:

A)Arrive at the forward rate quote that will be received by Star Industries using the term structure of interest rates given above. (Round off the final quote to two decimals).

B)Explain the quote arrived at above.

C)Identify clearly the risk faced by Star Industries and explain how the same can be hedged using an FRA (Explain the type of FRA to be used). Explain what is the FRA rate that will be applicable to Star Industries.

D)If at the time of FRA settlement the 6-month MIBOR rises to 5.5%, calculate the FRA settlement cash flow.

E)Calculate the cash flows and effective cost at the end of 12 months if the 6 month MIBOR rises to 5.5% as stated above.?

Answer rating: 100% (QA)

Notional Principal Rs 50 Mill Amount Needed after 6 months for 6 months so the quote will ... View the full answer