Exam 21: Forward and Futures Contracts

Exhibit 21.3 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) As a relationship officer for a money-center commercial bank, one of your corporate accounts has just approached you about a one-year loan for $3,000,000. The customer would pay a quarterly interest expense based on the prevailing level of LIBOR at the beginning of each quarter. As is the bank's convention on all such loans, the amount of the interest payment would then be paid at the end of the quarterly cycle when the new rate for the next cycle is determined. You observe the following LIBOR yield curve in the cash market: -Refer to Exhibit 21.3. If the bank wanted to hedge its exposure to falling LIBOR on this loan commitment, describe the sequence of transactions in the futures markets it could undertake.

Exhibit 21.3 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) As a relationship officer for a money-center commercial bank, one of your corporate accounts has just approached you about a one-year loan for $3,000,000. The customer would pay a quarterly interest expense based on the prevailing level of LIBOR at the beginning of each quarter. As is the bank's convention on all such loans, the amount of the interest payment would then be paid at the end of the quarterly cycle when the new rate for the next cycle is determined. You observe the following LIBOR yield curve in the cash market: -Assume that you manage an equity portfolio. The portfolio beta is 1.15. You anticipate a decline in equity values and wish to hedge $500 million of the portfolio. Calculate the number of contracts you would need to hedge your position and indicate whether you would go short or long. Assume that the price of the S&P 500 futures contract is 1105 and the multiplier is 250.

In the absence of arbitrage opportunities, the forward price should be equal to the spot price plus the cost of carry.

Which of the following is true when F_0,T < E(S_T)?

An investor who wants a long position in a ____ must first place the order with a broker, who then passes it on to the trading pit or electronic network. Details of the order are then passed on to the exchange clearinghouse.

Exhibit 22.8 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Consider the following information on put and call options for a common stock -The goal of a hedge transaction is to increase expected returns of a fundamental holding.

The inclusion of the following in the cost of carry model will increase the futures price

Exhibit 21.12 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Suppose you are a loan officer for a commercial bank and one of your clients has just approached you about a one-year loan for $4,000,000. Interest on the new loan will be paid at the end of each quarter based on the prevailing level of LIBOR at the beginning of each quarter. The LIBOR yield curve in the cash market is as follows: -Refer to Exhibit 21.12. A bond portfolio manager expects a cash inflow of $10,000,000. The manager plans to hedge potential risk with a Treasury futures contract with a value of $102,150. The conversion factor between the CTD and the bond specified in the Treasury futures contract is 0.88. The duration of bond portfolio is 6 years, and the duration of the CTD bond is 4.5 years. Indicate the number of contracts required and whether the position to be taken is short or long.

Exhibit 21.3 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) As a relationship officer for a money-center commercial bank, one of your corporate accounts has just approached you about a one-year loan for $3,000,000. The customer would pay a quarterly interest expense based on the prevailing level of LIBOR at the beginning of each quarter. As is the bank's convention on all such loans, the amount of the interest payment would then be paid at the end of the quarterly cycle when the new rate for the next cycle is determined. You observe the following LIBOR yield curve in the cash market: -Refer to Exhibit 21.3. Assuming the yields inferred from the Eurodollar futures contract prices for the next three settlement periods are equal to the implied forward rates, calculate in annual (360-day) percentage terms, the annuity that would leave the bank indifferent between making the floating-rate loan and hedging it in the futures market, and making a one-year fixed-rate loan.

Exhibit 21.3 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) As a relationship officer for a money-center commercial bank, one of your corporate accounts has just approached you about a one-year loan for $3,000,000. The customer would pay a quarterly interest expense based on the prevailing level of LIBOR at the beginning of each quarter. As is the bank's convention on all such loans, the amount of the interest payment would then be paid at the end of the quarterly cycle when the new rate for the next cycle is determined. You observe the following LIBOR yield curve in the cash market: -Refer to Exhibit 21.3. What is the implied 90-day forward rate at the beginning of the fourth quarter?

Exhibit 21.2 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Assume you are the Treasurer for the Johnson Pharmaceutical Company and in late July 2004, the company is considering the sale of $500 million in 20-year debentures that will most likely be rated the same as the firm's other debt issues. The firm would like to proceed at the current rate of 8.5%, but you know that it will probably take until November to bring the issue to market. Therefore, you suggest that the firm hedge the pending issue using Treasury bond futures contracts which each represent $100,000. -Refer to Exhibit 21.2. What is the dollar gain or loss assuming that future conditions described in Case 2 actually occur? (Ignore commissions and margin costs, and assume a naive hedge ratio.)

Exhibit 21.9 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) As a portfolio manager, you are responsible for a $150 million portfolio, 90 percent of which is invested in equities, with a portfolio beta of 1.25. You are utilizing the S&P 500 as your passive benchmark. Currently the S&P 500 is valued at 1202. The value of the S&P 500 futures contract is equal to $250 times the value of the index. The beta of the futures contract is 1.0. -Refer to Exhibit 21.9. If you anticipate a cash inflow of $2 million next week, how many futures contracts should you buy or sell in order to mitigate the effect of this inflow on the portfolio's performance (rounded to the nearest integer)?

Which of the following is not considered a "cost of carry"?

Financial futures have become an increasingly attractive investment alternative since the Chicago Board of Trade (CBOT) began trading them in 1977, and their hedging function partly accounts for the growth in trading. Which of the following statements concerning financial futures is true?

The cost-of-carry model is useful for pricing future contracts.

According to the cost of carry model the futures price is the present value of the spot price discounted at the risk free rate.

The Eurodollar futures contract is a popular hedging vehicle because it is based on the three-month LIBOR.

According to the cost of carry model the relationship between the spot (S₀) and futures price (F_0,T) is

Exhibit 21.2 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Assume you are the Treasurer for the Johnson Pharmaceutical Company and in late July 2004, the company is considering the sale of $500 million in 20-year debentures that will most likely be rated the same as the firm's other debt issues. The firm would like to proceed at the current rate of 8.5%, but you know that it will probably take until November to bring the issue to market. Therefore, you suggest that the firm hedge the pending issue using Treasury bond futures contracts which each represent $100,000. -Refer to Exhibit 21.2. How you would go about hedging the bond issue?

A riskless stock index arbitrage profit is possible if the following condition holds: F_0,T = S₀(1 + r_f - d)^T, where spot price now is S₀, value now of a futures contract expiring at time T is (F_0,T), r_f is the risk free rate and d is the dividend.