ABC Ltd. is planning to borrow a sum of ₹100 crore after 3 months. To hedge itself against the risk of increase in 91-days interest rate (which is currently 5.25%), the Company decided to trade in 91-Day Government of In

CS Professional · Capital Commodity and Money Market · PYQS · December 2021
ABC Ltd. is planning to borrow a sum of ₹100 crore after 3 months. To hedge itself against the risk of increase in 91-days interest rate (which is currently 5.25%), the Company decided to trade in 91-Day Government of India (GOI) Treasury Bill Future which is currently available at ₹95. The specification relating to these Future Contract are as follows: Unit of Trading Face value ₹2,00,000 Underlying 91-Day GOI Treasury Bill Contract Size ₹2,00,000 Settlement At Weighted Average Discount Yield obtained from weekly auction of 91-day T-Bill conducted by RBI on the day of expiry. You are required to: (iii) Calculate the effective cost of funds to ABC Ltd. (2) If on the day of settlement 91-Day Interest Rate falls to 4.75% and the Weighted Average Discount Yield obtained from weekly auction of 91-day T-Bill conducted by RBI comes out 4.70%.

Answer & Explanation:

If interest rate falls to 4.75% and settlement price for Future Contract comes to 4.70%. The settlement value of Future Contract: = 2000 (100 - 4.70 × 91 / 365) = ₹1,97,656 To close out the position ABC Ltd. will buy contract at ₹1,97,656 against sold earlier at ₹1,97,507. Hence overall loss shall be: 5063 (₹1,97,507 - ₹1,97,656) = ₹7,54,387 Thus, amount to be borrowed shall be: Total amount required ₹1,00,00,00,000 Add: Amt. of Loss on Future Contract ₹7,54,387 ₹1,00,07,54,387 Amount repayable after 91 days: = ₹1,00,07,54,387 (1 + 0.0475 × 91 / 365) = ₹1,00,07,54,387 (1.01184) = ₹1,01,26,03,319 Effective Interest Rate = (1,01,26,03,319 / 1,00,00,00,000 - 1) × 365 / 91 × 100 = 5.06% Alternative Solution The settlement value of Future Contract: = (₹2000 × 100) / (1 + 0.0470 × 91 / 365) = ₹1,97,683 To close out the position ABC Ltd. will buy contract at ₹1,97,683 against sold earlier at ₹1,97,537. Hence overall loss shall be: 5062 (₹191537 - ₹1,97,683) = ₹739052 Thus, amount to be borrowed shall be: Total amount required ₹1,00,00,00,000 Add: Amt. of Loss on Future Contract ₹7,39,052 ₹1,00,07,39,052 Amount repayable after 91 days: = ₹1,00,07,39,052 (1 + 0.0475 × 91 / 365) = ₹1,00,07,39,052 (1.01184) = ₹1,01,25,87,802 Effective Interest Rate = (1,01,25,87,802 / 1,00,00,00,000 - 1) × 365 / 91 × 100 = 5.05%

Topics: Interest Rate Futures

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