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exercise_5 (1) - MA826 FINANCE AND FINANCIAL REPORTING...

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MA826 FINANCE AND FINANCIAL REPORTING EXERCISE 5 1. The corporate treasurer of Cradley plc plans to borrow 10 million Italian lire in three months time for a period of three months. There is a possibility of a change in government in Italy and interest rates have recently been volatile. The treasurer has received a number of suggestions as to how to protect against interest rate risk. These include: (i) an FRA in Italian lira (ii) An Interest Rate Guarantee The following prices are available. It is now 1 April. FRA in three months for periods of up to six months at 86.25 The company can take up an IRG option at 12% plus 0.2% premium. The current base rate in Italy is 12%. Cradley can borrow in Italy at base plus ½%. Evaluate with hindsight the effects of the alternative strategies that have been suggested to the treasurer, if: (a) interest rates in Italy increase in three months’ time to a base rate of 14%; (b) interest rates in Italy decrease in three months’ time to a base rate of 11%.
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