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Sigma Company, a large manufacturer, is planning to sell an existing subsidiary and use the funds to buy land and build new factory. The proceeds of the sale are likely to be delayed, so the Directors have estimated that 10 million will be needed in 3 months time for a period of 6 months. Given this, the directors have decided that a bank loan would be appropriate as a form of finance rather than equity sources.

After checking that interest rate yield curves in the financial press are normal than inverted, the treasurer is now looking to hedge the interest rate exposure. Traditionally Sigma Company has used forward rate agreements (FRAs) for hedging interest rate risk exposure but the treasurer is now considering using interest rate futures, although he is concerned that futures will not be as good a hedge as the FRAs.

Sigma Companys bank have offered an FRA on the following terms:

3v9 FRA 7.2 7.8%.

Which of the following statements concerning FRAs and interest rate future is/are true?

(i) In both cases Sigma Company still needs to borrow the money at the market rate in three months time

(ii) Both have standardised contract sizes

(iii) Both result in a net gain or loss that can be offset against the loss or gain on the associated real world borrowing

Select one:

a. (i), (ii) and (iii)

b. (i) and (ii) only

c. (i) and (iii) only

d. (i) only

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