d) Brechin ple has borrowing outstanding of 350 million and the interest rate is re-set on...

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d) Brechin ple has borrowing outstanding of £350 million and the interest rate is re-set on every three months at the three-month £LIBOR + 3.5 per cent. The next date at which the interest rate will be re-set is September 1st. The company's treasurer anticipates that interest rates will increase before then and has decided to hedge the exposure to interest risk through the use of interest rate futures contracts. The current prices of interest rate futures is given below in the FT extract. FT EXTRACT INTEREST RATE FUTURES Open Feb 21 Euribor 3m" Euribor 3m* Euribor 3m* Euribor 3m" Euroswiss 3m* Mar Euroswiss 3m* Sterling 3m* Sterling 3m* Sterling 3m Sterling 3m* Futures information The contract size is £500,000 The tick size is £12.50 The initial margin is £500. ii. May Sep 96.24 Dec 96.41 Mar 96.49 97.28 97.44 Jun May Jun 94.73 Sep 95.02 Dec 95.26 Change Sett 95.80 -0.03 96.18 -0.09 96.36 -0.09 96.46 -0.08 97.27 -0.01 97.45 -0.02 94.36 +94.36 94.67 -0.08 94.97 -0.09 95.20 -0.08 High 96.25 96.41 96.50 97.28 97.47 94.74 95.04 95.27 Low Est. vol C 96.12 263,256 5 96.29 266,433 5 96.39 204,292 4 97.26 5,187 97.38 15,804 94.61 106,810 6 94.88 179,448 5 169,694 4 95.11 i. Set up the hedge today and briefly explain, using the appropriate terminology, what you have done. It should be assumed the spread on each side of the average futures quote is 0.04. On September 1st the futures contract stands at 98.00 this implies that the three months £LIBOR is 2 per cent. Illustrate the cash flows in the money market and the futures market, clearly setting out the effective cost. (7 marks) d) Brechin ple has borrowing outstanding of £350 million and the interest rate is re-set on every three months at the three-month £LIBOR + 3.5 per cent. The next date at which the interest rate will be re-set is September 1st. The company's treasurer anticipates that interest rates will increase before then and has decided to hedge the exposure to interest risk through the use of interest rate futures contracts. The current prices of interest rate futures is given below in the FT extract. FT EXTRACT INTEREST RATE FUTURES Open Feb 21 Euribor 3m" Euribor 3m* Euribor 3m* Euribor 3m" Euroswiss 3m* Mar Euroswiss 3m* Sterling 3m* Sterling 3m* Sterling 3m Sterling 3m* Futures information The contract size is £500,000 The tick size is £12.50 The initial margin is £500. ii. May Sep 96.24 Dec 96.41 Mar 96.49 97.28 97.44 Jun May Jun 94.73 Sep 95.02 Dec 95.26 Change Sett 95.80 -0.03 96.18 -0.09 96.36 -0.09 96.46 -0.08 97.27 -0.01 97.45 -0.02 94.36 +94.36 94.67 -0.08 94.97 -0.09 95.20 -0.08 High 96.25 96.41 96.50 97.28 97.47 94.74 95.04 95.27 Low Est. vol C 96.12 263,256 5 96.29 266,433 5 96.39 204,292 4 97.26 5,187 97.38 15,804 94.61 106,810 6 94.88 179,448 5 169,694 4 95.11 i. Set up the hedge today and briefly explain, using the appropriate terminology, what you have done. It should be assumed the spread on each side of the average futures quote is 0.04. On September 1st the futures contract stands at 98.00 this implies that the three months £LIBOR is 2 per cent. Illustrate the cash flows in the money market and the futures market, clearly setting out the effective cost. (7 marks)