The monthly cash budget of HYK Communications plc shows that the company is likely to need £18 million in two months’ time for a period of four months. Financial markets have recently been volatile, due to uncertainties about the impact of the ‘millennium bug’. If severe computer problems occur in January 2000, the finance director of HYK plc fears that short-term interest rates could rise by as much as 150 basis points. If few problems occur then short-term rates could fall by 50 basis points.
LIBOR is currently 6.5 per cent and HYK plc can borrow at LIBOR _ 0.75 per cent. The finance director does not wish to pay more than 7.50 per cent, including option premium costs, but excluding the effect of margin requirements and commissions.
LIFFE £500 000 three month futures prices: The value of one tick is £12.50
|
December
|
93.4
|
March
|
93.1
|
June
|
92.75
|
LIFFE £500 000 three months options prices (premiums in annual per cent)
|
|
Calls
|
|
|
Puts
|
|
Exercise price
|
December
|
March
|
June
|
December
|
March
|
June
|
92.5
|
0.33
|
0.88
|
1.04
|
–
|
–
|
0.08
|
93
|
0.16
|
0.52
|
0.76
|
–
|
0.2
|
0.34
|
93.5
|
0.1
|
0.24
|
0.42
|
0.18
|
0.6
|
1.93
|
94
|
–
|
0.05
|
0.18
|
0.36
|
1.35
|
1.92
|
Assume that it is now 1 December 1999 and that exchange traded futures and options contracts expire at the end of the month. Margin requirements and default risk may be ignored.
Required:
Estimate the results of undertaking EACH OF an interest rate futures hedge and an interest rate options hedge on the LIFFE exchange, if LIBOR:
(i) increases by 150 basis points; and
(ii) decreases by 50 basis points.
Discuss how successful the hedges would have been. State clearly any assumptions that you make.