2. Another alternative that you are considering it to go for options. You anticipate that the interest rate will fluctuate between 5.5 percent and 7.5 percent over the next two years. You have estimated your expenses and they are manageable if the interest rate remains within this range. The following options are available to you: Option Cap Cap Floor Floor
Strike Rate 8.5 percent 7.5 percent 5.5 percent 4.5 percent
Notional principal PKR 25 million PKR 25 million PKR 25 million PKR 25 million
Period 2 years 2 years 2 years 2 years
Premium Payable 2.68% 1.52% 2.35% 1.23%

a. Formulate a collar strategy. Support your answer with diagram (1 mark)
b. Calculate the net borrowing cost if the KIBOR turns out to be 8.58%, 6% and 3.25%
c. Discuss which of the alternative (option or FRA) is better for the treasurer. Justify your choice.