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Problems: 1. Cagle Manufacturing forecast a cash inflow of $10m in two months that it is considering investing in a Sun National Bank CD (certificate of deposit) for 90 days. Sun National Bank's jumbo CD pays a rate equal to the LIBOR. Currently such rates are yielding 5.5% (annual rate with an actual/360 day count convention), which is also equal to the forward interest rate. Cagle is concerned that short-term interest rates could decrease in the next two months and would like to lock in a rate now. Sun National suggests that Cagle hedge with a forward rate agreement (FRA). a) Define the terms of the FRA contract that would effectively hedge Cagle's future CD investment: BUY/SELL nxm FRA, n.a. (notional amount) b) Show in a table the payoffs that Cagle and Sun National would pay or receive at the maturity of the FRA given the following LIBORs: 5%, 5.25%, 5.5%, 5.75%, and 6%. LIBOR Cagle Manufacturing Sun National 5.00% 5.25% 5.50% 5.75% 6.00% c) Show in a table Cagle's cash flows from investing the $10m cash inflow plus or minus the FRA receipts or payments at possible LIBORs of 5%, 5.25%, 5.5%, 5.75%, and 6%. Account for lending/borrowing to move the FRA receipts or payments to the end of investment period when the CD matures. d) What is the hedged rate of return Cagle would earn from its $10m investment? Calculate: Total payment - $10,000,000 360 R = $10,000,000 90 Problems: 1. Cagle Manufacturing forecast a cash inflow of $10m in two months that it is considering investing in a Sun National Bank CD (certificate of deposit) for 90 days. Sun National Bank's jumbo CD pays a rate equal to the LIBOR. Currently such rates are yielding 5.5% (annual rate with an actual/360 day count convention), which is also equal to the forward interest rate. Cagle is concerned that short-term interest rates could decrease in the next two months and would like to lock in a rate now. Sun National suggests that Cagle hedge with a forward rate agreement (FRA). a) Define the terms of the FRA contract that would effectively hedge Cagle's future CD investment: BUY/SELL nxm FRA, n.a. (notional amount) b) Show in a table the payoffs that Cagle and Sun National would pay or receive at the maturity of the FRA given the following LIBORs: 5%, 5.25%, 5.5%, 5.75%, and 6%. LIBOR Cagle Manufacturing Sun National 5.00% 5.25% 5.50% 5.75% 6.00% c) Show in a table Cagle's cash flows from investing the $10m cash inflow plus or minus the FRA receipts or payments at possible LIBORs of 5%, 5.25%, 5.5%, 5.75%, and 6%. Account for lending/borrowing to move the FRA receipts or payments to the end of investment period when the CD matures. d) What is the hedged rate of return Cagle would earn from its $10m investment? Calculate: Total payment - $10,000,000 360 R = $10,000,000 90

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