Suppose you work for a company that expects to borrow one-year from now to finance a new building. What interest rate risk is it exposed to? How should it hedge this risk with futures? How should it hedge the risk with options? Which strategy would you recommend and why?

1.Interest rate risk arises when an individual pr organization gets a loan or buys bonds since
these assets generate interest. 

Step-by-step explanation

Interest rates are not stable and constantly fluctuate which mean
that they could lead to a change in the assets value which exposes one to interest change risk
where the assets value could decrease due to fluctuations in interest rates. For example, if the
company uses bonds to borrow, then an increase in the interest rates would cause the bond prices
to fall reducing the value of the bond.
2.Futures are contracts that state the price which assets will be sold or bought at a specified time.
In such type of contract, the price at which those assets will be sold is pre-determined. The
interest rate risk can be hedged by this contract. This is because a borrower will sign a contract
with the creditor and determine the total amount to be paid back by the company and this could
be in installments or the whose principle plus interest. By doing these, the company will avoid
paying very high amounts than the borrowed one.
3.If a company chooses to go for bonds, it will have to enter into derivative contract which
specify the terms at which each those bonds should be bought back by the issuing organizations
to hedge against these bonds. Contracts for loan can also be engaged in where the company will
enter into a contract with the creditor to determine the amount that the company will ay including
interest. This will reduce the instance of any fluctuations in interest rates affecting the value of
the borrowed amount.
4.The best strategy to use is to use futures to hedge against the interest rate risk. This is because
the futures are easy to use for both loan and bonds. These contract will determine the total
amount to be paid by the debtor and hence will give the company target value and time to repay
the debt.