CASE STUDY- DERIVATIVE AND RISK MANAGEMENT

Narayan informs Manoj that the loan rate will be based on MIBOR and there will be a premium of 200 basis points above MIBOR. The manager also indicates that the interest on the loan will be paid every three months even though the interest would be compounded every month. The tenure of the loan will be two years, and the interest rate will be set every three months. Manoj is not very clear about the terms of the loan and has approached you on April 1 to get an idea of (1) what the likely forward rates would be and (2) what would be the interest amount every three months during the life of the loan. Manoj wants to borrow INR 1,000,000 on July 1. Since the loan is based on MIBOR, you have found out the MIBOR rates currently available for various periods to be as shown in Table 1. Discussion Questions 1. If the bank uses the same MIBOR rates to calculate the forward rates at which the loan will be given, calculate the rates for every three months starting from July 1. 2. Calculate the interest amount that will be paid every three months.

CASE STUDY Modern Chemicals is planning to borrow at a future time. The manager of Modern Chemicals, Manoj, approaches a bank to get an idea of what the rate could be in the future. The bank manager, Narayan, is ready to enter into a forward contract for the loan. Table 1 MIBOR Rates Narayan informs Manoj that the loan rate will be based on MIBOR and there will be a premium of 200 basis points above MIBOR. The manager also indicates that the interest on the loan will be paid every three months even though the interest would be com- pounded every month. The tenure of the loan will be two years, and the interest rate will be set every three months. Manoj is not very clear about the terms of the loan and has approached you on April 1 to get an idea of (1) what the likely forward rates would be and (2) what would be the interest amount every three months during the life of the loan. Manoj wants to borrow INR 1,000,000 on July 1. Since the loan is based on MIBOR, you have found out the MIBOR rates currently available for various periods to be as shown in Table 1. Maturity (months) Rate (per cent) 3 3.85 6 4.10 9 4.22 12 4.34 15 4.52 18 4.72 Discussion Questions 1. If the bank uses the same MIBOR rates to calculate the for- ward rates at which the loan will be given, calculate the rates for every three months starting from July 1. 2. Calculate the interest amount that will be paid every three months. 21 4.94 24 5.15