ExpertACCA · Question 02 · Treasury and Advanced Risk Management Techniques
SECTION B: ADVISORY REPORT
This question is based on the Heavy Manufacturing and Aerospace sector.
AeroForge Ltd is a specialized manufacturer of aerospace components. The company has recently secured a major contract to supply landing gear for a new commercial airliner. To finance the expansion of its manufacturing plant, AeroForge will take out a $50 million loan in exactly 6 months' time. The loan will be for a period of 5 years, with interest payable annually at a floating rate of SOFR + 1.8%.
The current Secured Overnight Financing Rate (SOFR) is 4.0%. The Treasury team at AeroForge is highly concerned that interest rates will rise over the next 6 months, severely impacting the profitability of the new contract.
The company's bank has offered the following hedging instruments:
-
Interest Rate Swap:
AeroForge can enter into a swap starting in 6 months. The bank is quoting a swap rate where AeroForge pays a fixed rate of 4.5% and receives SOFR.
-
Interest Rate Options (Collar):
AeroForge can purchase an interest rate cap at a strike rate of 4.8% for a premium of 0.6% (payable upfront). To offset this cost, AeroForge can sell an interest rate floor at a strike rate of 3.5% for a premium of 0.4% (receivable upfront).
Assume that in 6 months' time, SOFR could either rise to 5.5% or fall to 3.0%.
Requirements:
(a) Calculate the effective annual interest rate that AeroForge will pay under BOTH the Interest Rate Swap and the Interest Rate Collar, under the two scenarios where SOFR in 6 months is 5.5% and 3.0%. (15 marks)
(b) Discuss the advantages and disadvantages of using an Interest Rate Collar compared to a Swap in this scenario. Furthermore, briefly discuss whether AeroForge's treasury department should operate as a cost center or a profit center. (10 marks)
SECTION B: ADVISORY REPORT
This question is based on the Heavy Manufacturing and Aerospace sector.
AeroForge Ltd is a specialized manufacturer of aerospace components. The company has recently secured a major contract to supply landing gear for a new commercial airliner. To finance the expansion of its manufacturing plant, AeroForge will take out a $50 million loan in exactly 6 months' time. The loan will be for a period of 5 years, with interest payable annually at a floating rate of SOFR + 1.8%.
The current Secured Overnight Financing Rate (SOFR) is 4.0%. The Treasury team at AeroForge is highly concerned that interest rates will rise over the next 6 months, severely impacting the profitability of the new contract.
The company's bank has offered the following hedging instruments:
-
Interest Rate Swap:
AeroForge can enter into a swap starting in 6 months. The bank is quoting a swap rate where AeroForge pays a fixed rate of 4.5% and receives SOFR. -
Interest Rate Options (Collar):
AeroForge can purchase an interest rate cap at a strike rate of 4.8% for a premium of 0.6% (payable upfront). To offset this cost, AeroForge can sell an interest rate floor at a strike rate of 3.5% for a premium of 0.4% (receivable upfront).
Assume that in 6 months' time, SOFR could either rise to 5.5% or fall to 3.0%.
Requirements:
(a) Calculate the effective annual interest rate that AeroForge will pay under BOTH the Interest Rate Swap and the Interest Rate Collar, under the two scenarios where SOFR in 6 months is 5.5% and 3.0%. (15 marks)
(b) Discuss the advantages and disadvantages of using an Interest Rate Collar compared to a Swap in this scenario. Furthermore, briefly discuss whether AeroForge's treasury department should operate as a cost center or a profit center. (10 marks)
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