A company is due to receive €2,500,000 two-months from today and wishes to save the funds for three months. Money market interest rate spreads for short-term euro transactions are presented in the table below. Money Market Euro Interest Rate Spreads (%)1 month2 months3 months4 months5 months6 months0.20 - 0.250.28– 0.330.35 – 0.400.45 – 0.560.60 – 0.670.75 – 0.83 Assume that the company wishes to undertake a money market hedge to fix the future deposit rate. Explain the character of the company’s interest rate risk exposure and calculate the annualised forward interest rate that it can achieve using the current interest rates. Base calculations on months rather than days.

The company's interest rate risk exposure is known as "basis risk." This is the risk that the…

Answered: A company is due to receive €2,500,000…

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter16: Working Capital Policy And Short-term Financing

Section: Chapter Questions

Problem 14P

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A company is due to receive €2,500,000 two-months from today and wishes to save the funds for three months. Money market interest rate spreads for short-term euro transactions are presented in the table below.

Money Market Euro Interest Rate Spreads (%)
1 month	2 months	3 months	4 months	5 months	6 months
0.20 - 0.25	0.28– 0.33	0.35 – 0.40	0.45 – 0.56	0.60 – 0.67	0.75 – 0.83

Assume that the company wishes to undertake a money market hedge to fix the future deposit rate. Explain the character of the company’s interest rate risk exposure and calculate the annualised forward interest rate that it can achieve using the current interest rates. Base calculations on months rather than days.

Definition Definition Financial market that deals in securities or assets that are short-term in nature. The money market is responsible for keeping up the liquidity of the businesses and the organizations. These securities are usually held for a period of 12 months or less and are issued by institutions that require cash or funds for their short-term cash flow requirements. The money market is regulated by the federal government.

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