Malvi Inc. (Malvi), whose home currency is USD, is looking to borrow 5 million for a six month time period, starting in three months' time (today's date is 31 March). The interest rate on the borrowing will be fixed at the point when the borrowing is taken out. The financial manager of Malvi is concerned about a possible change in interest rates during the next three months impacting on the borrowing cost. He wants to hedge the risk arising from the future borrowing and has received the following quotes from his bank for a forward rate agreement (FRA):

3v6 4.6% - 3.6%

3v9 4.8% - 3.8%

6v9 5.1% - 3.9%

The financial manager is also concerned with the foreign currency risk associated with the repayment of the denominated borrowing in nine months' time. The following details have been provided by Redwood's FX broker:

Spot rate ($ per Euro) 1.2047 - 1.2112

Nine month forward discount (in cents) 0.67 - 0.97

Futures contracts (contract size of 130,000) with the following expiry dates:

June contract: $1.2095

September contract: $1.2125

December contract: $1.2160

An OTC option contract is available to convert into 5 million in nine months' time at an exchange rate of $1.2140/1. The premium cost for this contract is fixed at $40,000.

1. Explain, with supporting calculations, how a FRA could be used to hedge the 5 million borrowing due to be taken out in three months' time (assume that the spot interest rate on 30th June is 6% - 5%).
2. Explain, with supporting calculations, how each of the following hedging products could be used by Malvi for its exposure to the exchange rate risk on the amount due to be repaid on the denominated borrowing in nine months' time. Assume that the spot rate in nine months' time is $1.2344/1.

a) currency forward

b) currency futures

c) OTC currency option