Badge Ltd needs to borrow 4.1m for 9 months commencing in six months time. It wants to use hedging tools to protect against increases in interest rates. Further information (shown below) has been gathered to hedge the interest rate risk between now and when the 4.1m is to be borrowed.

S_o 3.5%

S_6months 4.25%

Futures Price 96.31 (Current) 95.74 (In 6 months time)

(Underlying bond size of the futures contract is 150k)

Option prices 0.17%/ (Call Option with K = 3.85%)

0.08%/ (Put Option with K = 3.45%)

1. Another suggestion given to Badge Ltd was to consider using a collar to hedge the interest rate on the future proposed borrowing.

Explain the process of creating a collar (using the options given above) and illustrate the net payments for the following possible future spot interest rates: i) 3.2%; ii) 3.8%; iii) 4.25%