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# 2. The CEO is afraid interest rates will increase by 0.5% in the...

2. The CEO is afraid interest rates will increase by 0.5% in the U.K. The U.K. subsidiary has a current short term loan of £1,000,000 that expires 90 days from now, but will have to borrow the same amount again after expiry for operational expenses that will be incurred. Calculate the expected outcome of a 90 day forward rate agreement entered into in the United Kingdom to hedge against the increase in interest rates on £1,000,000. The current risk free United Kingdom rate is to be used as the agreed rate for the calculation. Also assume the settlement rate is the current risk free rate plus 0.5%. Advise the CEO whether HighTech should take a long or short position to hedge the risk of the increasing interest rates. Information from the following table can be used for your calculations:

Annual risk free interest rates:

USA 0.140%

Japan 0.025%

South Korea 0.664%

UK 0.077%

Australia 0.112%

South Africa 4.545%

1. Show your calculation by applying the correct formula (6 marks)
2. Do you recommend that HighTech should be the seller or buyer of the forward rate agreement? (1 mark)
3. Briefly explain how the forward rate agreement will assist Hightech in terms of the interest rate that it will have to pay if it borrows £1,000,000 again for 90 days after expiry of the current loan. (3 marks)

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