Chantal DuPont is the CFO of Vetements Verdun, a manufacturer of specialty clothing and uniforms, located in northern France. The firm is currently undergoing an expansion which will
require DuPont to draw down 25 million on Vetements Verdun’s credit line as a 90 day bridge loan before the mortgage closes. The money will not be needed for 60 days, at which point the interest rate will be determined. The interest rate on the loan will be based off 90day LIBOR.
DuPont is becoming concerned because of signs that interest rates may begin to rise. The firm
cannot afford to have its borrowing costs increase significantly over current rates. In response to
DuPont’s concerns, the company’s CEO, Viviane Lamarre, has asked DuPont to hedge the firm’s
borrowing costs, even if that entails some near term outlays.
DuPont and Lamarre discuss entering into a forward rate agreement (FRA) to hedge Vetements
Verdun’s interest rate exposure on the credit line. Current LIBOR rates are:
Libor rate
30day 2.6%
60day 2.8%
90day 3.0%
120day 3.2%
150day 3.3%
180day 3.4%
They decide to go forward with the hedge and DuPont enters into the appropriate FRA for the full
amount of 25 million.
In the first 30 days of the FRA, the fixed income markets rally sharply. The new set of LIBOR rates,
on the thirteenth day of the FRA, is:
Libor rate
30day 2.2%
60day 2.4%
90day 3.6%
120day 3.8%
150day 3.8%
180day 3.8%
At the settlement date, the interest savings on the loan term is 23,750. DuPont tells Lamarre, “I am looking forward to cashing our settlement check for 23,750.” Lamarre adds, “Yes, and on top of that we get to borrow for 90 days at a below market rate.” Both DuPont and Lamarre are pleased with their decision to hedge.
Q: Thirty days into the FRA, what is the value of the contract from Vetements Verdun’s perspective?
A. Due 43,943.
B. Due 45,000.
C. Owes 43,943.
Kindly solve the question. Thanks
Can you please upload the entire item set this question is from??
I feel the information you have entered is not the entire comprehensive information.
done, Can you answer the question
first calculate the current FRA rate which will be 3.6%.
Now calculate the rate of FRA after 30 days it will come tp 4.33%
they had a bet that the interest rate will rise but instead it fell so, they the saved interest is due by their side.
saved interest = (0.0433-0.036) * 25 m * 3/12 = 44500
PV = 44500 FV 3.8 I/Y, 120/360 = N and CPT PV =43950 (approx) Due
the answer will be OPTION A
The answer is given according to the approximation done.
Why have you done PV with 3.8 I/Y as we have to do PV 90 days back with 3.6 as I/Y (This is after 30 days so after 30 days only 90 days left and we have to do PV at 90 days)
If you see this is written in the starting of the question “The money will not be needed for 60 days,”
And now 30 days have passed which means 120 days are still remaining and so we use 3.8%
after 30 days have passed, only 90 days left as total are 120 days (30*120 FRA), so how 120 days rate will be used? Can you explain this I am not able to understand 3.8% logic.