Normanby Bank expects that one of its wholesale customers will fully repay a loan contract worth $2 million in six months' time. The bank plans to reinvest these proceeds in new 3-month Treasury bills. The bank's managers are concerned that Treasury bill interest rates are falling; hence these securities may become more expensive to purchase.

(i)  Should Normanby Bank buy or sell Forward Rate Agreements (FRAs) to hedge this risk and why? 

(ii) Assume Normanby Bank enters into a 90-day FRA contract (FRA rate = 8%) to hedge its interest rate risk. On the settlement day, the Treasury bill floating rate has fallen to 7%. Will Normanby Bank gain or lose on this FRA? Calculate the compensation payment in dollar terms (show all workings). 

Answer rating: 100% (QA)

i Normanby Bank should buy Forward Rate Agreements FRAs to hedge against the risk of falling Treasur... View the full answer