Exam 15: Forward, Futures, and Swap Contracts

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 Megabuks.

The futures exchange requires each customer to post an initial margin account.

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. Calculate the current price of the futures contract.

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 15.5. Assume that a month later the price of the September T-Bill future is 93 and the price of the Eurodollar future is 90.25. Calculate the profit on the Eurodollar futures position.

When F_0,T > E(S_T), it is known as

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. Assuming that three-month LIBOR is 5.00 percent on the rate determination day, and the contract specified settlement in advance, describe the transaction that occurs between the dealer and Darden.

Assume the exchange rate is GBP 1.35/USD, the US risk-free rate is 7.0 percent, and the UK risk-free rate is 3.0 percent. What is the implied one-year forward rate?

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 15.11. 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)?

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

In the cost of carry model, the inclusion of storage costs will increase the futures price.

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

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) December futures on the S&P 500 stock index trade at 250 times the index value of 1187.70. Your broker requires an initial margin of 10 percent on futures contracts. The current value of the S&P 500 stock index is 1178. -Refer to Exhibit 15.14. Suppose at expiration the futures contract price is 250 times the index value of 1170. Disregarding transaction costs, what is your percentage return?

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 percent in exchange for receiving three-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 percent. The notional principal is $50,000,000 and that there are 60 days between month 3 and month 6. -Refer to Exhibit 15.18. Suppose that three-month LIBOR is 4.00 percent on the rate determination day, and the contract specified settlement in advance, describe the transaction that occurs between the dealer and Newport.

On the settlement date for a forward rate agreement (FRA) contract, the difference between the two interest rates is multiplied by the FRA's par value and prorated by the length of the holding period.

If you have entered into a currency futures hedge for the Japanese yen in connection with buying Japanese equipment and if the yen goes from 110 yen/$1 to 100 yen/$1, you will lose in the spot market but have an offsetting gain in the futures market.

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

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. What is the dollar gain or loss assuming that future conditions described in Case 1 actually occur? (Ignore commissions and margin costs .)

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. Assume that one year after the swap was initiated the fixed rate on a new three-year receive fixed pay floating LIBOR swap has risen to 9 percent per year, calculate the market value of the 8 percent fixed rate bond based on $100 face value. Settlement is on a semiannual basis.

Interest rate parity is a key concept in managing risk in the commodities market.

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 steepen, the appropriate NOTE AGAINST BOND futures spread strategy would be