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CMA Final · Strategic Financial Management · Interest Rate Derivatives

On 1 July, Pragati Ltd expects to borrow ₹50 crore for three months from 1 October. The current borrowing rate is 7% p.a. To hedge, it sells 50 three-month interest rate futures contracts (face value ₹1 crore each) at 93.00 (implied rate 7%). On 1 October it borrows at 8% p.a. and closes the futures at 92.00. Ignoring margin costs and taxes, what is Pragati's effective annualised borrowing rate after the hedge?

The effective rate is 7.0%. Selling the futures at 93.00 and closing at 92.00 gains ₹25,000 per contract, or ₹12,50,000 on 50 contracts. This reduces the three-month interest of ₹1 crore to ₹87.5 lakh, which annualises to 7% and matches the locked-in rate.

  1. A7.0%Correct
  2. B8.0%
  3. C9.0%
  4. D6.5%

Explanation

The futures price falls by 1.00 (100 basis points). The gain per contract is ₹1 crore × 1% × 3/12 = ₹25,000, so 50 contracts give ₹12,50,000. Unhedged interest is 50 crore × 8% × 0.25 = ₹1,00,00,000. Net cost = ₹87,50,000, which is 1.75% for the quarter, or 7.0% annualised. 8.0% ignores the hedge. 9.0% treats the futures gain as a loss.

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