Suppose you need to pay $1M to finance a project in 3 months. Bank ABC will provide a one year loan with the amount of $1M in 3 months and bank XYZ offers a 3mth×15mth FRA with notional value of $1M and forward rate r_{0, 3mth, 15mth} = 10% (simple interest rate).

1. What should you do to fully hedge your borrowing cost (against uncertain spot interest rate)?
2. 
   
3. Suppose the one year simple interest rate in 3 months rises to 12%. How much money do you owe Bank ABC in 15 months? When and how much money will you pay/receive from bank XYZ? What are your actual cost of borrowing?
4. 
   
5. Redo part (ii) assuming the one year simple interest rate drops to 5% in 3 months.

Answer rating: 100% (QA)

Solution i What should you do to fully hedge your borrowing cost You should enter into the 3mth15mth ... View the full answer