April 1st 2016 – As a treasurer of ABC Company Ltd, a Singaporean company operating in Singapore but with USD as a functional currency, you just signed a 5-year loan with UBS Bank where you borrow 10 million USD at a rate of 1-year Libor + 200 bps (basis points). The 1- year Libor rate on April 1st 2016 is 0.75%.
However, since the beginning of the year, there has been persistent market expectations that the US Federal Reserve might intensify its raising of short term interest rates from their historically – and abnormal – low level.
(a) Calculate – where possible – the amount of interest that you will pay to UBS Bank.
(b) Analyse the risks (or lack thereof) that the loan exposes ABC Company Ltd to.
(c) Formulate a strategy using swaps to hedge this risk.