Exam 15: Forward, Futures, and Swap Contracts

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 15.3. 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.

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. Calculate the overall profit.

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Assume that you observe the following prices in the T-Bill and Eurodollar futures markets -Refer to Exhibit 15.6. Assume that a month later the price of the September T-Bill future is 96.25 and the price of the Eurodollar future is 95.9. Calculate the profit on the T-Bill futures position.

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 15.3. If 90-day LIBOR rises to the levels "predicted" by the implied forward rates, what will the dollar level of the bank's interest receipt be at the end of the second quarter?

Stock index futures are useful in providing a hedge against movements in an underlying financial asset.

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 percent in exchange for receiving three-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 percent. (Assume a notional principal of $50,000,000.00 and that there are 60 days between month 3 and month 6.) -Refer to Exhibit 15.16. Assuming that three-month LIBOR is 5.6 percent 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.

Equity swaps are equivalent to portfolios of forward contracts calling for the exchange of cash flows based on two different investment rates: (1) a variable debt rate and (2) the return to an equity index.

Forward rate agreements usually require substantial collateral.

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Assume that you observe the following prices in the T-Bill and Eurodollar futures markets -Refer to Exhibit 15.6. Assume that a month later the price of the September T-Bill future is 96.25 and the price of the Eurodollar future is 95.9. Calculate the profit on the Eurodollar futures position.

In a forward rate agreement (FRA), two parties agree today to a future exchange of cash flows based on two different interest rates.

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 third quarter?

The basis is the spot price minus the future price.

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The Skalmory Corporation has entered into a three-year interest rate swap, with semiannual settlement, to pay a fixed rate of 7.5 percent per year and receive six-month LIBOR. The notional principal is $10,000,000. -Refer to Exhibit 15.17. What is the market value of the swap to the Skalmory Corporation?

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 bonds 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 15.2. How you would go about hedging the bond issue?

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 15.159 Assume that one year later the fixed rate on a new three-year receive fixed pay floating LIBOR swap has risen to 9 percent per year. Settlement is on a semiannual basis. Calculate the market value of the FRN based on $100 face value.

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 15.3. If 90-day LIBOR rises to the levels "predicted" by the implied forward rates, what will the dollar level of the bank's interest receipt be at the end of the third quarter?

If you were bearish on the near-term outlook for the stock market but did not want to sell your portfolio, you could hedge against the decline by selling stock index futures.

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 15.3. If 90-day LIBOR rises to the levels "predicted" by the implied forward rates, what will the dollar level of the bank's interest receipt be at the end of the fourth quarter?

In an interest rate swap, the fixed rate payer profits if interest rates fall.

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 percent in exchange for receiving three-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 percent. (Assume a notional principal of $50,000,000.00 and that there are 60 days between month 3 and month 6.) -Refer to Exhibit 15.16. Assuming that three-month LIBOR is 5.6 percent on the rate determination day, and the contract specified settlement in advance, describe the transaction that occurs between the dealer and Chimichango.