Nestle rolls over a $20 million loan priced at LIBOR4 on a four- month basis. Th
ID: 1211808 • Letter: N
Question
Nestle rolls over a $20 million loan priced at LIBOR4 on a four- month basis. The company feels that interest rates are rising and that rates will be higher at the next roll over date in four months. Suppose the current LIBOR4 is 5.4375%. Suppose Nestle can use an FRA at 6% from Credit Suisse to reduce its interest rate risk.
(a) In four months, interest rates have risen to 6.5%. How much will Nestle receive/pay on its FRA? What will be Nestle’s hedged interest expense for the upcoming four-month period?
(b) Redo the problem if interest rates have fallen to 5.5%.
Explanation / Answer
a. the accepted interested rate as on today is 6% from Credit Suisse to reduce its credit risk, if the market interest goes to 6.5% after 4 months, now Nestle can raise the gap 0.5% (6.5%-6%) from credit suisse.
in terms of dollars it is= $20,000,000*0.05/3= $333,333
b. if the interest falls to 5.5%, then Nestle pays that interest only to the buyer.