Future rate

1. PAF – Karachi Institute of Economics and Technology
Course: Financial Risk Management
Faculty: Ali Sajid
Class ID: Total Marks: 3
Examination: Assignment 2 Date:
Student Name: ID:
1. A corporate treasurer needs to hedge the risk of the interest rate on a future transaction. The risk is associated
with the rate on 180-day Euribor in 30 days. The relevant term structure of Euribor is given as follows:
30-day Euribor 5.75%
210-day Euribor 6.15%.
a. State the terminology used to identify the FRA in which the manager is interested.
b. Determine the rate that the company would get on an FRA expiring in 30 days on 180-day Euribor.
c. Suppose the manager went long this FRA. Now, 20 days later, interest rates have moved significantly
downward to the following:
10-day Euribor 5.45%
190-day Euribor 5.95%
The manager would like to know where the company stands on this FRA transaction. Determine the
market value of the FRA for a €20 million notional principal.
d. On the expiration day, 180-day Euribor is 5.72 percent. Determine the payment made to or by the
company to settle the FRA contract.
2. The spot rate for British pounds is $1.76. The U.S. risk-free rate is 5.1 percent, and the U.K. risk-free rate is 6.2
percent; both are compounded annually. One-year forward contracts are currently quoted at a rate of $1.75.
a. Identify a strategy with which a trader can earn a profit at no risk by engaging in a forward contract,
regardless of her view of the pound's likely movements. Carefully describe the transactions the trader
would make. Show the rate of return that would be earned from this transaction. Assume the trader's
domestic currency is U.S. dollars.
b. Suppose the trader simply shorts the forward contract. It is now one month later. Assume interest rates
are the same, but the spot rate is now $1.72. What is the gain or loss to the counterparty on the trade?
c. At expiration, the pound is at $1.69. What is the value of the forward contract to the short at expiration?