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Scenario: You are the treasurer of XYZ Corp. Your company is considering a potential six-month, $10 million LIBOR-based, floating-rate bank loan to fund a factory expansion. The terms of the loan are shown in the table. Terms of Loan June 28, 2007 September 28, 2007 December 28, 2007 Borrow $10 million at June 28 LIBOR + 300 basis points (bps) Pay interest for the first 3 months Pay back the principal plus interest June 28 LIBOR = 6% Roll loan over at the September 28 LIBOR + 300 bps You anticipate that the LIBOR rate will rise by September. To hedge this risk, you are considering using the September Eurodollar futures contract. The contract expires September 28, 2007, has a discount yield of 5.5%, and a US$1-million contract size. Your Task: Create a June 28, 2007 floating-to-fixed rate plan utilizing Eurodollar future contracts. In your plan, ignore the cash flow issues regarding initial margin requirements, marking to market, and any timing mismatch between exchange-traded futures contract cash flows and the interest payments due in March. Your plan should result in a fixed-rate loan, assuming an increase in the LIBOR rate to 9.0% by September 28, 2007, which is still at 9.0% through December 28, 2007.
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- Posted on May. 16, 2011 at 05:02:44AM
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