Ican 2025 Strategic Financial Management Question 4

Tolu Ltd (TL) is expecting to receive $24,000,000 on 1 February 2026, which will be invested until it is required for a large project on 1 June 2026. Due to uncertainty in the markets, the company is of the opinion that it is likely that interest rates will fluctuate significantly over the coming months although it is difficult to predict whether they will increase or decrease. TL’s treasury team wants to hedge the company against adverse movements in interest rates using one of the following derivative products: • Forward rate agreements (FRAs) • Interest rate futures • Options on interest rate futures TL can invest funds at the relevant inter-bank rate less 20 basis points. The current inter-bank rate is 4.09%. However, TL is of the opinion that interest rates could increase or decrease by as much as 0.9% over the coming months. The following information and quotes are provided from an appropriate exchange on $ futures and options. Margin requirements can be ignored. Three-month $ futures, $2,000,000 contract size Prices are quoted in basis points at 100 – annual % yield December 2025: 94.80 March 2026: 94.76 June 2026: 94.69 Options on three-month $ futures, $2,000,000 contract size, option premiums are in annual %. Calls Puts June 0.271 0.520 December March June Strike December 0.342 0.432 0.523 94.50 0.090 0.097 0.121 0.289 95.00 0.312 BK Bank has offered the following FRA rates to TL: 1-7: 4.37% 3-4: 4.78% 3-7: 4.82% 4-7: 4.87% March 0.119 0.417 It can be assumed that settlement for the futures and options contracts is at the end of the month and that basis diminishes to zero at contract maturity at a constant rate, based on monthly time intervals. Assume that it is 1 November 2025 now and that there is no basis risk.