But in August, the sum realized is going to be:
0.11 X 90
20 [1 - ----------- ] = $ 19.45 million
360The shortfall = $ 0.025 million = $ 25,000
To hedge against the interest rate rise, the company sells 20 T-bill September future
contracts and repurchases them on August 15.
The gain on the future contract is 90.2 – 89.6 or 60 ticks. This is equal to 20 X 60 X 25 =
$ 30,0 00
Thus, the shortfall is more than compensated by hedging.
Illustration
Problem 14
A treasury manager after five months will need to borrow Rs.300,000 months. The
current rates are as follows:
Duration Borrowing rates Lending rates
(Percent) (Percent)
3 - months 9.5 10.0
5 - months 9.8 10.2
8 - months 10.0 10.5
9 - months 10.2 10.8
The manager wants to ensure the rate that he would have to pay on his borrowings. What
should he do and what is the rate he can lock in?
Solution 14
Since he has to borrow after 5 months for a period of 3 months, the rates that concern him
are those corresponding to 5 months and 8 months.
He should borrow for 8 months at 10.5 percent and lend this sum immediately for 5
months at 9.8 percent. Let us say his effective rate is I.