Today is December 1^st and the current 90-day bank bill rate is 10%. Your accounting team has discovered that you will have a cash flow shortage over the first quarter of next year. As such you will have to borrow $1,000,000 for three months from January 1st. As you are concerned about interest rate risk you have gone to your bank and asked them for a solution. They have offered you a loan with the interest rate capped at 11% that you can choose to use if the going bank bill interest rate is higher when it comes time for you to borrow on January 1^st.

1. a). Show how this hedge would work if the going bank bill rate is 12% on January 1^st. Show all cash flows.
2. b). Show how this hedge would work if the going bank bill rate is 8% on January 1^st.
3. c). Discuss the difference between a forwards/futures and options? What are the relative advantages and disadvantages of each?

Answer rating: 100% (QA)

A When the bank rate will go to 12 on January 1st T... View the full answer