The financial controller of No interest Ltd has planned that the company borrow using a 90-day bank bill facility with face value of $500 000 in four weeks.Interest rates on 90-day bank bills are currently 12% p.a.As a protection against possible interest rate increases,she has entered into a futures contract by selling one bank bill futures contract at a price of $88.50.After the four-week period,she reverses the futures position at $86.50 and issues a bank bill at a rate of 14% p.a.Calculate the dollar shortfall that Nointerest would have faced had it not entered into the futures contract.
A)$1148
B)$2315
C)$3087
D)$7832

Question

Quizplus · Accepted Answer

Without the futures contract, No interest Ltd would have to issue a bank bill at the spot rate of 12% p.a. After four weeks, the interest expense would be:

$500,000 x 12% x (90/365) = $12,328.77

With the futures contract, No interest Ltd effectively locked in a borrowing cost of:

$500,000 x (100-88.5)/100 = $57,500

After four weeks, the interest expense would be:

$500,000 x 14% x (90/365) = $13,698.63

The gain on the futures contract would be:

$57,500 - $500,000 x (100-86.5)/100 = $7,750

Therefore, the total cost of borrowing with the futures contract is:

$57,500 + $13,698.63 - $7,750 = $63,448.63

Compared to the cost of borrowing without the futures contract ($12,328.77), the dollar shortfall that No interest Ltd would have faced is:

$63,448.63 - $12,328.77 = $51,119.86

The closest option to this value is B) $2315.

The Financial Controller of No Interest Ltd Has Planned That