GXJ Co, whose home currency is the dollar, wishes to borrow €12 million for a period of si
The finance director of GXJ Co would like to hedge the interest rate risk arising from the future loan and the company’s bank has offered a 3–9, 4·5%–3·5% forward rate agreement.
The finance director is also concerned about the foreign currency risk associated with the euro interest payment which would be due in nine months’ time.
The following exchange rates are available:
Required:
(a) Evaluate the proposed forward rate agreement as a way of managing the interest rate risk anticipated by GXJ Co. (3 marks)
(b) Analyse the foreign currency risk associated with the future interest payment of GXJ Co and briefly discuss ways that this risk might be hedged. (4 marks)
(c) Explain the nature of four-way equivalence in the relationship between spot exchange rates, forward exchange rates and future (expected) spot rates. (3 marks)