Electraspace is consumer electronics wholesaler. The business of the firm is highly seasonal in nature. In 6 months of a year, firm has a huge cash…

(i) By entering into an FRA, firm shall effectively lock in interest rate for a specified future in the given it is 6 months. Since, the period of 6 months is starting in 3 months, the firm shall opt for 3 × 9 FRA locking borrowing rate at 5.94%. In the given scenarios, the net outcome shall be as follows: If the rate turns out to be 4.50% If the rate turns out to be 6.50% FRA Rate 5.94% 5.94% Actual Interest Rate 4.50% 6.50% Loss/ (Gain) 1.44% (0.56%) FRA Payment / (Receipts) €50 m × 1.44% × 1/2 = €360,000 €50m x 0.56% × 1/2 = (€140,000) Interest after 6 months on €50 Million at actual rates = €50m x 4.5% × 1/2 = €50m x 6.5% × 1/2 = €1,125,000 = €1,625,000 Net Out Flow € 1,485,000 €1,485,000 Thus, by entering into FRA, the firm has committed itself to a rate of 5.94% as follows: € 1,485,000 / € 50,000,000 × 100 × 12/6 = 5.94% (ii) Since firm is a borrower it will like to off-set interest cost by profit on Future Contract. Accordingly, if interest rate rises it will gain hence it should sell interest rate futures. No. of Contracts = (Amount of Borrowing / Contract Size) × (Duration of Loan / 3 months) = (€ 50,000,000 / € 50,000) × (6 / 3) = 2000 Contracts The final outcome in the given two scenarios shall be as follows: If the interest rate turns out to be 4.5% If the interest rate turns out to be 6.5% Futures Course Action: Sell to open 94.15 94.15 Buy to close 95.50 (100 - 4.5) 93.50 (100 - 6.5) Loss/ (Gain) 1.35% (0.65%) Cash Payment (Receipt) for Future Settlement €50,000×2000×1.35%×3/12 = €337,500 €50,000×2000×0.65%×3/12 = (€162,500) Interest for 6 months on €50 million at actual rates €50 million × 4.5% × 1/2 = €11,25,000 €50 million × 6.5% × 1/2 = €16,25,000 €1,462,500 €1,462,500 Thus, the firm locked itself in interest rate € 1,462,500 / € 50,000,000 × 100 × 12/6 = 5.85%