- 15 Marks
FM – May 2018 – L3 – SC – Q5 – Financial Risk Management
Use of forward rate agreements and interest rate management tools for borrowing concerns in Katangwa Limited.
Question
Katangwa Limited will need to borrow ₦50 million in three months’ time for a period of six months. The company is concerned that interest rates are expected to rise over the next few months.
Interest rates and forward rate agreements (FRAs) are currently quoted as follows:
- Spot 5.75 – 5.50
- 3 – 6 FRA 5.82 – 5.59
- 3 – 9 FRA 5.94 – 5.64
Required:
a. Explain how a forward rate agreement (FRA) may be useful to the company. Illustrate this on the basis that interest rates: i. Rise to 6.50% ii. Fall to 4.50%
(8 Marks)
b. Compare the use of interest rate futures with FRA in this instance. (4 Marks)
c. Explain how interest rate guarantees or a short-term interest rate cap could be used. (3 Marks)
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