Exam 23: Swap Contracts,convertible Securities,and Other Embedded Derivatives

Exhibit 23.10 Use the Information Below for the Following Problem(S) TexMex Corporation has decided to borrow $50,000,000 for six months in two three-month issues. The corporation is concerned that interest rates will rise over the next three months. Thus, the corporation purchases a 3 × 6 FRA whereby the corporation pays the dealer's quoted fixed rate of 3.5% in exchange for receiving 3-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from Newport Inc. at its bid rate of 3%. The notional principal is $50,000,000 and that there are 60 days between month 3 and month 6. -Refer to Exhibit 23.10.Suppose that 3-month LIBOR is 4.00% on the rate determination day,and the contract specified settlement in advance,describe the transaction that occurs between the dealer and Newport.

The conversion parity price is equal to the par value of a convertible bond divided by the number of shares into which it can be converted.

Warrants differ from options in a number of ways.Which of the following statements about warrants and options is false?

The exercise price of The American Dairy Company is $17.You purchase the warrants for $4.00 each when American Dairy's stock price is $20.00 a share.Each warrant entitles you to purchase one share of ADC stock.Calculate your percentage gain assuming the warrant premium drops by 50% and you sell your warrants when the stock reaches $30.00 per share.

Exhibit 23.9 Use the Information Below for the Following Problem(S) The Skalmory Corporation has entered into a 3-year interest rate swap, with semiannual settlement, to pay a fixed rate of 7.5% per year and receive 6-month LIBOR. The notional principal is $10,000,000. -Refer to Exhibit 23.9.What is the market value of the swap to the Skalmory Corporation?

Exhibit 23.1 Use the Information Below for the Following Problem(S) A company buys an interest rate cap that pays the difference between LIBOR and 8% if LIBOR exceeds 8%. Current LIBOR is 7%. The amount of the option is $2,500,000, and the settlement is every 6 months. Assume a 360 day year. -Refer to Exhibit 23.1.Find the payoff if LIBOR closes at 7.8%.

Exhibit 23.3 Use the Information Below for the Following Problem(S) Chimichango Industries has decided to borrow $50,000,000.00 for six months in two three-month issues. As the Treasurer, you are concerned that interest rates will rise over the next three months and the rate upon which the second payment will be based will be undesirable. (The amount of Chimichango's first payment will be known at origination.) To reduce the company's interest rate exposure, you decide to purchase a 3 × 6 FRA whereby you pay the dealer's quoted fixed rate of 5.91% in exchange for receiving 3-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from Megabuks Industries at its bid rate of 5.85%. (Assume a notional principal of $50,000,000.00 and that there are 60 days between month 3 and month 6.) -Refer to Exhibit 23.3.How much compensation does the dealer receive for transaction costs,credit risk and other costs associated with matching the FRA's?

Exhibit 23.2 Use the Information Below for the Following Problem(S) Darden Industries has decided to borrow $25,000,000.00 for six months in two three-month issues. As the Treasurer, you are concerned that interest rates will rise over the next three months and the rate upon which the second payment will be based will be undesirable. (The amount of Darden's first payment will be known at origination.) To reduce the company's interest rate exposure, you decide to purchase a 3 × 6 FRA whereby you pay the dealer's quoted fixed rate of 4.5% in exchange for receiving 3-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from McIntire Industries at its bid rate of 4%. (Assume a notional principal of $25,000,000.00 and that there are 60 days between month 3 and month 6.) -Refer to Exhibit 23.2.Assuming that 3-month LIBOR is 5.00% on the rate determination day,and the contract specified settlement in advance,describe the transaction that occurs between the dealer and Darden.

Exhibit 23.3 Use the Information Below for the Following Problem(S) Chimichango Industries has decided to borrow $50,000,000.00 for six months in two three-month issues. As the Treasurer, you are concerned that interest rates will rise over the next three months and the rate upon which the second payment will be based will be undesirable. (The amount of Chimichango's first payment will be known at origination.) To reduce the company's interest rate exposure, you decide to purchase a 3 × 6 FRA whereby you pay the dealer's quoted fixed rate of 5.91% in exchange for receiving 3-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from Megabuks Industries at its bid rate of 5.85%. (Assume a notional principal of $50,000,000.00 and that there are 60 days between month 3 and month 6.) -Refer to Exhibit 23.3.Assuming that 3-month LIBOR is 5.6% on the rate determination day,and the contract specified settlement in arrears at month 6,describe the transaction that occurs between the dealer and Chimichango.

The following are all advantages of having an equity swap market except

Exhibit 23.4 Use the Information Below for the Following Problem(S) Black Gold Industries (BGI) is an independent oil producer with production capacity of 500,000 barrels per month. Due to the cost structure of the business, BGI needs to receive $56.50 per barrel in order to remain solvent. On the other side of this situation is Petrochemicals Unlimited (PU) which uses an average of 500,000 barrels of West Texas crude oil in its normal production operations. The nature of PU's business is such that they will financially suffer if they have to pay more than an average of $57.80 per barrel for oil over the next six years. To hedge against their exposure to volatile oil prices, BI and PU contact a swap dealer to arrange the six-year oil swap described below: - Settlement is made monthly. - The notional principal is for 500,000 barrels per month. - The monthly WTI index value is determined as the average of the daily settlement prices for the crude oil futures contract traded on the New York Mercantile Exchange (NYMEX). - The swap dealer pays BGI $57.00 per barrel. - BGI pays the swap dealer the average NYMEX Oil futures price per barrel. - PU pays the swap dealer $57.50 per barrel. - The swap dealer pays PU dealer the average NYMEX Oil futures price per barrel. -Refer to Exhibit 23.4.Barring default by PU or BGI,how much compensation does the swap dealer receive each month?

A pay-fixed interest rate swap can be viewed as equivalent to

Exhibit 23.6 Use the Information Below for the Following Problem(S) BioTech Industries has debentures outstanding (par value $1,000) convertible into the company's common stock at $30. The coupon rate is 11 percent payable semiannually and they mature in 10 years. -Refer to Exhibit 23.6.Calculate the conversion value of the bond if the stock price is $27.00 per share.

Forward rate agreements usually require substantial collateral.

Exhibit 23.10 Use the Information Below for the Following Problem(S) TexMex Corporation has decided to borrow $50,000,000 for six months in two three-month issues. The corporation is concerned that interest rates will rise over the next three months. Thus, the corporation purchases a 3 × 6 FRA whereby the corporation pays the dealer's quoted fixed rate of 3.5% in exchange for receiving 3-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from Newport Inc. at its bid rate of 3%. The notional principal is $50,000,000 and that there are 60 days between month 3 and month 6. -Refer to Exhibit 23.10.Suppose that 3-month LIBOR is 4.0% on the rate determination day,and the contract specified settlement in arrears at month 6,describe the transaction that occurs between the dealer and Newport.

____ has coupons denominated in a currency other than that of their principal.

A ____ contract can be viewed as a prepackaged series of forward rate agreements to buy or sell LIBOR at the same fixed rate.

By attaching a convertible feature to a bond issue a firm can often get a lower rate of interest on its debt.

Exhibit 23.7 Use the Information Below for the Following Problem(S) The WallMal Company has entered into a 4-year interest rate swap, with semiannual settlement, to pay a fixed rate of 8% per year and receive 6-month LIBOR. The notional principal is $50,000,000. -Refer to Exhibit 23.7.Assuming that one year after the swap was initiated the fixed rate on a new 3-year receive fixed pay floating LIBOR swap has fallen to 7% per year,calculate the market value of the 8% fixed rate bond based on $100 face value.Settlement is on a semiannual basis.

Exhibit 23.4 Use the Information Below for the Following Problem(S) Black Gold Industries (BGI) is an independent oil producer with production capacity of 500,000 barrels per month. Due to the cost structure of the business, BGI needs to receive $56.50 per barrel in order to remain solvent. On the other side of this situation is Petrochemicals Unlimited (PU) which uses an average of 500,000 barrels of West Texas crude oil in its normal production operations. The nature of PU's business is such that they will financially suffer if they have to pay more than an average of $57.80 per barrel for oil over the next six years. To hedge against their exposure to volatile oil prices, BI and PU contact a swap dealer to arrange the six-year oil swap described below: - Settlement is made monthly. - The notional principal is for 500,000 barrels per month. - The monthly WTI index value is determined as the average of the daily settlement prices for the crude oil futures contract traded on the New York Mercantile Exchange (NYMEX). - The swap dealer pays BGI $57.00 per barrel. - BGI pays the swap dealer the average NYMEX Oil futures price per barrel. - PU pays the swap dealer $57.50 per barrel. - The swap dealer pays PU dealer the average NYMEX Oil futures price per barrel. -Refer to Exhibit 23.4.Describe the transaction that occurs between PU and the swap dealer if the monthly average oil futures settlement price is $55.50.