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Interest Rate Risk Management Strategies

The document discusses interest rate risk management for a Pakistani company needing to borrow Rs. 21 million and deposit Rs. 42 million, both starting in three months. It outlines the current KIBOR rate, potential hedging methods including FRAs, futures, and options, and provides current prices for these instruments. The company is concerned about fluctuations in interest rates and seeks to determine the effective interest rates under different scenarios of rate changes.

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Sameer asif
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8 views1 page

Interest Rate Risk Management Strategies

The document discusses interest rate risk management for a Pakistani company needing to borrow Rs. 21 million and deposit Rs. 42 million, both starting in three months. It outlines the current KIBOR rate, potential hedging methods including FRAs, futures, and options, and provides current prices for these instruments. The company is concerned about fluctuations in interest rates and seeks to determine the effective interest rates under different scenarios of rate changes.

Uploaded by

Sameer asif
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

INTEREST RATE RISK MANAGEMENT

Question 1
A Pakistani company will need to make borrowing of Rs. 21 million for two months, starting in three months’ time. It is now
15th March. The current KIBOR rate is 5% and the company can borrow at KIBOR + 0.75%.
The company is concerned about the possibility of an increase in short-term interest rates during the next two months, and
it is looking at methods of hedging its exposure to the risk. The three methods it is considering are interest rate futures,
options on interest rate futures and an FRA.
Current prices for futures, options and FRAs are as follows:
Forward rate agreements (FRAs)
• 3 v 5 FRA at 5.38 – 5.32
• 3 v 6 FRA at 5.43 – 5.46
• 3 v 8 FRA at 5.52 – 5.44
Interest rate futures
Notional three-month loan of Rs. 500,000
Value of tick = Rs. 12.50
March 94.74
June 94.61
September 94.50
Options on interest rate futures
Premium cost expressed as an annual interest rate %
Calls Puts
Strike price
March June September March June September
94.75 0.140 0.200 0.280 0.320 0.390 0.500
95.00 0.124 0.080 0.120 0.470 0.560 0.850
Required: Determine the effective interest rate if KIBOR rate has increased to 6% when company borrows Rs. 21 million
in 15th June.
Question 2
A Pakistani company will need to make a deposit of Rs. 42 million for two months, starting in three months’ time. It is now
15th March. The current KIBOR rate is 5% and the company can invest at KIBOR - 0.50%.
The company is concerned about the possibility of decrease in short-term interest rates during the next two months, and it
is looking at methods of hedging its exposure to the risk. The three methods it is considering are interest rate futures, options
on interest rate futures and an FRA.
Current prices for futures, options and FRAs are as follows:
Forward rate agreements (FRAs)
• 3 v 5 FRA at 5.38 – 5.32
• 3 v 6 FRA at 5.43 – 5.46
• 3 v 8 FRA at 5.52 – 5.44
Interest rate futures
Notional three-month deposit of Rs. 500,000
Value of tick = Rs. 12.50
March 94.74
June 94.61
September 94.50
Options on interest rate futures
Premium cost expressed as an annual interest rate %
Calls Puts
Strike price
March June September March June September
94.75 0.140 0.200 0.280 0.320 0.390 0.500
95.00 0.124 0.080 0.120 0.470 0.560 0.850
Required: Determine the effective interest rate if KIBOR rate has decreased to 4% when company deposits an amount of
Rs. 42 million on 15th June.

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