Question 1a. Today is April 2016. Hillary will need to borrow $1,000,000 for 90 days this coming...

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Question 1a. Today is April 2016. Hillary will need to borrow $1,000,000 for 90 days this coming October. Interest rate futures contracts for October exercise are quoted at XXXXXXXXXXThe notional contract value is $1,000,000. Hillary decides to hedge her exposure. The 90-day interest rate turned out to be 10.5% in October.Required:Demonstrate how Hillary’s hedging strategy locks her borrowing rate at 11.75% regardless of the spot interest rate in October. [15 marks]b. Michelle often speculates on interest rates and she forecasts that there will be a rise in short term interest rates in 4 months’ time. She intends to use the 180-day Treasury bill, with face value of $1,000,000. Her usual position involves 5 contracts. Today she initiates a speculative position with 2 T-bill contracts at 98.40 and another 3 contracts at 96.80 one month later.Required:Calculate Michelle’s trading gains / losses after 4 months if she squares her positions at 99.00 then.Your answer must include an explanation on the futures position that she should take to capitalize on her forecast. [10 marks][Total = 25 marks]Question 2

David · Accepted Answer

SUMMER EXAMINATIONS - YEAR
 
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SEMESTER I EXAMINATION – 2016 
Academic Year 2016/17 
 
Bachelor of Science (Singapore) BBS 23 (Full-Time) 
 
FIN3002S 
 
Treasury and Risk Management 
 
 
Professor Keith Cuthbertson 
Professor Don Bredin 
Dr. Cal Muckley * 
Mr. Chong Chin Siong* 
 
 
 
Time Allowed: 3 Hours 
 
 
 
Instructions for Candidates 
 
Candidates must answer ANY FOUR (4)out of six (6) questions.  
All questions carry equal marks. 
 
Calculators Allowed: 
 
ONE non-programmable Scientific Calculator 
Brand – Any; Model –Any 
And / or 
ONE non-programmable Financial Calculator: 
 Brand-Texas Instruments, Model- BAII Plus Basic 
Brand-Texas Instruments, Model- BAII Plus Professional 
Brand- Casio, Model FC100V 
Brand- Casio, Model FC200V
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Question 1A       
In early 2012, the spot exchange rate between the Swiss Franc and U.S. 
dollar was 1.0404 (USD per franc). Interest rates in the U.S. and Switzerland 
were 0.25% and 0% per annum,respectively, with continuous compounding. 
The quoted three-month forward exchange rate was1.0300 (USD per franc).  
  
 Required: 
 
(i) Explain how an arbitrage strategy is possible and calculate the risk-free 
profit based on a loan of 1,000,000 Swiss francs.            
          [8 marks] 
Answer: 
Continuous compounding rate is determined using the exponential.  
 
U.S. Interest rate: 
Exponential = exp(0.25%*3/12)  
                    = 1.000625 
 
1.0404 USD = 1 franc 
 
Forward rate 1.0300 USD = 1 franc 
 
Borrow in Swiss franc 1,000,000 convert it to USD. 
 
Amount in USD = 1,000,000*1.0404  
                          = $1,040,400 
 
Rate of return after 3 months = $1,040,400* 1.000625 
                                                = $1,041,050.25 
 
Converting using forward rate to Swiss franc. 
 
Swiss franc = $1,041,050.25/1.0300 
                    = 1,010,728.398 
 
Profit = 1010728.398 – 1000000 
          = 10728.398 franc 
 
 
(ii) How does your answer to part (i) change if the exchange rate is 1.0500 
(USD per franc)? Base your answer on a loan of USD 1,000,000.  
          [8 marks] 
Answer: 
If the forward rate is 1.0500 instead of 1.0300
Converting USD to Swiss franc.
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Amount in Swiss franc = $1,000,000/1.0404 
                                     = 961,168.78
There is no return on their investment.
The amount of interest to be paid for $1,000,000 loan is:
Amount to be repaid = $1,000,000*1.000625 
                                  = $1,000,625
Amount to be converted to USD using the 3-month forward rate  
= 961,168.78*1.0500 
= $1,009,227.219 
Profit = 1,009,227.219 – 1,000,625 
    = $8,602.219
 It will result profit to the investor.
Question 1B 
The spot price of gold today (31 December 2016) is $1373 per ounce. The 
storage cost and insurance fee for gold is $2 per ounce per month, payable in 
arrears. Interest rates are expected to be 1 percent per month (compound) for 
the next year. You are presented with the following information on gold futures 
contracts:
Contract size: 100 ounces of gold 
Initial margin: 5 percent of contract value
Maturity      Futures price Estimated spot price 
End March 2017    1390    1392 
End June 2017    1423    1437
Required:
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Describe the arbitrage strategy of buying the near-dated contract and selling 
the far-dated contract, and calculate the gains / losses from this arbitrage.  
            [9 marks] 
Answer: 
Buying the contract at $1,390 and sell the contract is $1,423 per ounce.  
Initial margin = Contract size * Value * Margin Percentage 
                      = 100*$1,390 *5% 
                      = $6,950*5% 
                      = $347.50
The remaining amount is borrowed.
Borrowings = $6,950-$347.50 
                   = $6,602.5
Three month total repayment amount on borrowings = $6,602.5*(1+1%)^3 
                                                                                     = $6,802.56
Interest repayment = $200.06
Position = $347.50 + $1,390 - $1,423
Using the spot market rate the profit or loss from the position: 
Long position loss = $1,373-$1,390  
                               = -$17
Short-position profit = $1,493 - $1,373  
                                 = $120
Gross position on opening day = $120 - $7  
                                                   = $113
For the entire contract = ($113*100) - $6,950 
                                    = $4,350
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Gain from the long position at estimated price = $1,392 - $1,390  
                                                                          = $2
Loss from the short position at estimated price = $1,423 - $1,437  
                                                                            = -$14
Net position = (($2-$14)*100) - $347.50 - $200.06 
                    = -$1,747.56
There is loss in the position.  
          [Total = 25 marks]
Question 2
On 1st May 2017, Kings plc intends to invest in a 90-day bill in 270 days’ time. 
The total face value is $1,000,000. Concerned that interest rate movements 
may be adverse before the investment, the company assembled the following 
FRA quotations from a broker:

Question 1 a. Today is April 2016. Hillary will need to borrow $1,000,000 for 90 days this coming October. Interest rate futures contracts for October exercise are quoted at XXXXXXXXXXThe notional...

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