The following scenario relates to questions 367 to 371
HMC Co. a large manufacturer, is planning to sell an existing subsidiary and use the funds to buy land and build a new factory. The proceeds of the sale are likely to be delayed, so the directors have estimated that $10 million will be needed in 3 months’ time for a period of 6 months. Given this, the directors have decided that a bank loan would be appropriate as a form of finance rather than equity sources.
After checking that interest rate yield curves in the financial press are normal rather than inverted, the treasurer is now looking to hedge the interest rate exposure. Traditionally HMC Co. has used forward rate agreements (FRAs) for hedging interest rate risk exposure but the treasurer is now considering using interest rate futures, although she is concerned that futures will not be as good a hedge as the FRAs.
HMC Co.’s bank have offered an FRA on the following terms:
3v9 FRA 7.2 – 7.8%
367. Which TWO of the following are possible reasons why the Directors decided that a bank loan was preferable to equity in this case?