Exam 15: Forward, Futures, and Swap Contracts

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 15.7. What will the dollar level of the bank's interest receipt be at the end of the first quarter?

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The S&P 500 stock index is at 1300. The annualized interest rate is 4.0 percent, and the annualized dividend is 2 percent. You are currently considering purchasing a two-month futures contract for your portfolio. -Refer to Exhibit 15.12. If the futures contract was currently available for 1280, indicate the appropriate strategy that would earn an arbitrage profit.

In late January 2011, Starlight Corporation is considering the sale of $50 million in 10-year bonds rated AAA. The issue will most likely be registered and sold some time in April. Therefore, Starlight Corporation desires to hedge the pending issue using Treasury bond futures contracts, which each represent $100,000. Explain how you would go about hedging the bond issue?

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 percent in exchange for receiving three-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 percent. (Assume a notional principal of $25,000,000.00 and that there are 60 days between month 3 and month 6.) -Refer to Exhibit 15.15. How much compensation does the dealer receive for transaction costs, credit risk, and other costs associated with matching the FRAs?

In the absence of arbitrage opportunities, the forward contract price should be equal to the current price plus

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Consider a portfolio manager with a $20,500,000 equity portfolio under management. The manager wishes to hedge against a decline in share values using stock index futures. Currently a stock index future is priced at 1250 and has a multiplier of 250. The portfolio beta is 1.25. -Refer to Exhibit 15.10. Assume that a month later the equity portfolio has a market value of $20,000,000 and the stock index future is priced at 1150 with a multiplier of 250. Calculate the profit on the stock index futures position.

Like hedging, arbitrage results in increased returns with a disproportional increase in risk.

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The WallMal Company has entered into a four-year interest rate swap, with semiannual settlement, to pay a fixed rate of 8 percent per year and receive six-month LIBOR. The notional principal is $50,000,000. -Refer to Exhibit 15.19. Indicate the market value of the swap to the WallMal Company.

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) A three-month T-bond futures contract (maturity 20 years, coupon 6 percent, face $100,000) currently trades at $98,781.25 (implied yield 6.11 percent). A three-month T-note futures contract (maturity 10 years, coupon 6 percent, face $100,000) currently trades at $101,468.80 (implied yield 5.80%). Assume semiannual compounding. -Refer to Exhibit 15.4. If you expected the yield curve to flatten, the appropriate note against bond futures spread strategy would be

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The S&P 500 stock index is at 1100. The annualized interest rate is 3.5 percent, and the annualized dividend is 2 percent. -Refer to Exhibit 15.9. If the futures contract was currently available for 1250, calculate the arbitrage profit.

Like future contracts, all forward contracts are processed by the exchange clearinghouse.

Because futures contracts are "marked-to-market" daily, the gains and losses are settled daily.

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) An international investment firm buys an interest rate swap that pays the difference between LIBOR and 6 percent if LIBOR exceeds 6 percent. Current LIBOR is 5 percent. The amount of the option is $1,500,000, and the settlement is every three months. Assume a 360-day year. -Refer to Exhibit 15.20. Find the payoff if LIBOR closes at 4.7 percent.

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

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 15.7. What is the implied 90-day forward rate at the beginning of the second quarter?

In the absence of arbitrage opportunities, the forward contract price should be equal to the current spot price plus interest.

While LIBOR is usually used with forward rate agreements, it is rarely used with other interest rate agreements.

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) A futures contract on Treasury bond futures with a December expiration date currently trade at 103:06. The face value of a Treasury bond futures contract is $100,000. Your broker requires an initial margin of 10 percent. -Refer to Exhibit 15.8. Calculate the initial margin deposit.

Consider a pension fund manager who wishes to convert $10 million from notes paying LIBOR to stocks using an equity swap. The equity swap should be structured so that

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