Student Name: Hai Yen Hoang

Student ID: M00962098

FIN4480 Coursework – Case study 1 – Version Number 998

Task 1.a

- MNZ Plc needs to protect its position against the decrease in interest rate in 91 days.

The term of money market hedge involves the following:

- Borrow the present value of £124,750,000 for 91 days. The rate that the bank charges for
borrowing is 0.88%. Hence:

124,750,000
£ borrow= =£ 124,476,901.089

( )
0.0088
1+
365
91

- Deposit this amount for 182 days. The 182-day saving rate is 0.91%, so the future value will
be:

[ ( )]
0.0091
£ 124,476,901.089∗ 1+ =£ 125,041,719.291
365
182

Technically, the companies created a future deposit of £124,750,000 in 91 days and get back
£125,041,719.291 in 182 days,

- therefore, the forward rate is:

FRA= ( £ 125,041,719.291−£ ) × 91 =0.009379

124,750,000 365
£ 124,750,000

Which is equivalent to 0.9379%.

Task 1.b

If the company entered an FRA with a forward rate of 0.9379%, and the three-month £LIBOR in 91
days stands at 1.46% on the settlement date, which exceeds the agreed forward rate. The company
will have to compensate the bank with the payment is:

124,750,000∗91
( 0.009379−0.0146 )∗£
365
Settlement amount = =−£ 161,781.823
0.0146
1+
365
91

The future value of this settlement amount will be:

( )
0.0146
£ 161,781.823∗ 1+ =£ 162,370.709
365
91

In the market, the company can deposit at 1.46%, therefore they will receive:

The total effective interest payment is equal to:

( )
0.0146
£ 124,750,000∗ =£ 454,090
365
91

The company will offset the loss by the gain, so the total effective interest payment is equal to:

£ 454,090−£ 162,370.709=£ 291,719.291

which is equivalent to a rate of:

£ 291,719.291
∗365
£ 124,750,000
=0.009379
91

Task 1.c

MNS Plc wants to deposit for 91 days, starting from 30 th January 2022, meaning the ending date will be
on 01st May 2022. Given the provided information, the company may hedge their investment by using
the June sterling future with the delivery day on 18 th June, because by purchasing the June future, the
company can more effectively protect itself from potential fluctuations in interest rates after the deposit
period started.
The three-month sterling future with a June delivery has an opening price of 98.8657. The interest rate
for a 91-day period sterling deposit beginning in June is:

100−98.8657=1.1343 percent

The company aims to safeguard against potential decreases in interest rates, which would lower its
savings rate. In such a scenario, if interest rates decline, the value of the futures contract increases,
leading to a gain for MNZ PLC when purchasing the contract. The number of contracts the company
intends to purchase given the size of the contract is £500,000:

£ 124,750,000
=250 contracts
£ 500,000

In 91 days (the time that MNZ receives its notional amount £ 124,750,000), the future price is 98.49,
but the company purchased at 98.8657, so loss of buying future contract:

98.8657−98.49=0.3757

Which is equivalent to about 38 basic points, so the cash value of each basic point is:

£ 500,000∗0.0001∗0.25=£ 12.50

So, the loss of the company is calculated:

−38∗250∗£ 12.50=−£ 118,750

The future value of the loss will be:

( )
0.0146
£ 118,750∗ 1+ =£ 119,182.25
365
91

Interest that MNZ Plc receive from deposit:

124,750,000∗0.0146∗91
£ =£ 454,090
365

Effective interest rate:

( £ 454,090−£ 119,182.25
£ 124,750,000 )∗365 =0.010768(¿ 1.0768 %) Task 1.d
91

i. Whether to hedge the deposit rate on the forthcoming cash flow

The company needs to consider various factors including market conditions at that time, the company’s
cost sensitivity, risk tolerance, transaction size, and the overall company’s financial health analysis, given
the provided information to decide to hedge or not hedge. If the company decides to hedge whatever
the rate is, they expect the interest is likely to rise rather than fall given the current rate. If the company
decides not to hedge because of the available information, there is not enough evidence to affirm that
the company will make mistakes or not.

ii. Whether to enter an FRA, or trade futures contracts to hedge the interest rate:
- We cannot compare the two methods because the two rates are not comparable, the deposit
starting from 30th January will end on 01st May. However, the future contracts have a delivery
date of 18th June. Moreover, the rate can be changed on a daily basis. The rate after 01 st May can
be unpredictable.
- The implied actual rate should be the average rate of 18 th June and 16th March, which can be
used to compare with FRA. With the March future price, the interest rate for a sterling deposit is
0.9743% while the June future price, the interest rate for a sterling deposit is 1.1343%.
Therefore, the average is 1.0543%.
- As mentioned in the previous calculation in part c, the effective interest rate is 1.0768% while
The FRA offered a marginally lower rate of 0.9379%. Specifically, on a notional amount of
£124,750,000, a 14-bps difference would equate to a three-month difference to about £43,188.
Whether this difference is small or large by MNC Pls expectation would be based on their
financial conditions.
- Moreover, the actual number of future contract purchased is 249.5 which is round up to 250
contracts which equivalent to 0.5 contracts or £250,000, so the company overhedge their
position, which leads to additional costs and can make further loss when future price deceases
and interest increases.