Name Status Principal Amount of loan/ (in millions) Duration (time) Interest rates of Borrowing/ Lending Strike Rate (K) (PLR) Premium (P) (lumpsum)…

CA Final · Advanced Financial Management · PYQS · January 2026
Name Status Principal Amount of loan/ (in millions) Duration (time) Interest rates of Borrowing/ Lending Strike Rate (K) (PLR) Premium (P) (lumpsum) If PLR rate at the end of first 6-months (Reset Period) AB Ltd. Borrower 5.00 5 Year PLR+0.5 p.a. 8% 0.4% 10% p.a. XY Ltd. Depositor 2.00 3 Year PLR-0.5 p.a. 8% 0.5% 6% p.a. You are required to: (i) Elaborate the strategy to be adopted by both the companies to hedge against the risk of interest rate fluctuations. (ii) Premium paid/received based on the strategy to be adopted in (i) using 8% p.a. as the reference rate. (iii) Net Gain/loss due to hedging to both the companies.

Suggested Answer and Working Notes:

(i) Strategy to be adopted by both the companies: AB Ltd. - Buying Cap OptionXY Ltd. – Buying Floor Option (ii) Premium paid by both companies First of all we shall calculate premium payable to bank as follows: P = [rp / ((1+i) t - 1) / (i * (1+i) t )] x A or P = rp * PVAF(4.00%,10) x A Where P = Premium A = Principal Amount rp = Rate of Premium i = Fixed Rate of Interest t = Time For AB Ltd. = [0.004 / ((1/0.04) - (1 / (0.04 * 1.04 10 )))] x 5,000,000 or (1 / 8.1108) x 5,000,000 x 0.4% = 2465.85 or 2,466 For XY Ltd. = [0.005 / ((1/0.04) - (1 / (0.04 * 1.04 6 )))] x 20,000,000 or (1 / 5.2421) x 2,000,000 x 0.5% = 1907.63 or 1,908 (iii) Net Gain/ Loss due to hedging to both the companies AB Ltd. Gain on Interest for Cap Option 2% Amount of Gain 5 millions x 2% x (1/2) 50,000 Less: Premium Paid 2,466 Net Gain 47,534 XY Ltd. Gain on Interest for Cap Option 2% Amount of Gain 2 millions x 2% x (1/2) 20,000 Less: Premium Paid 1,908 Net Gain 18,092 Alternative Solution if students have considered reset period (n-1) (i) Strategy to be adopted by both the companies AB Ltd. - Buying Cap OptionXY Ltd. - Buying Floor Option (ii) Premium paid by both companies First of all we shall calculate premium payable to bank as follows: P = [rp / ((1+i) t - 1) / (i * (1+i) t )] x A or P = rp * PVAF(4.00%, 9) x A Where P = Premium A = Principal Amount rp = Rate of Premium i = Fixed Rate of Interest t = Time For AB Ltd. = [0.004 / ((1/0.04) - (1 / (0.04 * 1.04 9 )))] x 5,000,000 or (1 / 7.4353) x 5,000,000 x 0.4% = 2689.87 or 2,690 For XY Ltd. = [0.005 / ((1/0.04) - (1 / (0.04 * 1.04 5 )))] x 20,000,000 or (1 / 4.4518) x 2,000,000 x 0.5% = 2246.28 or 2246 (iii) Net Gain/ Loss due to hedging to both the companies AB Ltd. Gain on Interest for Cap Option 2% Amount of Gain 5 millions x 2% x (1/2) 50,000 Less: Premium Paid 2,690 Net Gain 47,310 XY Ltd. Gain on Interest for Cap Option 2% Amount of Gain 2 millions x 2% x (1/2) 20,000 Less: Premium Paid 2,246 Net Gain 17,754

Topics: Interest Rate Risk Management

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