QUESTION 1
(a)
A company buys five September sterling futures on the
Chicago Mercantile Exchange at a price of $1.4235.
Calculate the value of the
contract.
Note: Each contract is for a
standard amount of £62, 500 in sterling, and the tick size worthy $6.25
($0.0001/£ x £62, 500).
(b)
Assume that, on 1st November the spot rate
of the €/$ was $1.58 and the price on a December futures contract was $1.59.
Assume that the euro depreciates over November, so that by 30th
November it is worth $1.51.
I.
What do you think would happen to the futures price
over the month of November? Why?
II.
If you expected this to occur, would you have purchased
or sold a December futures contract on Euro on 1st November?
Explain.
QUESTION 2
•
On Monday morning, you short one NSE Tshs.
Futures contract containing Tshs. 50,000,000 at a price of Kshs. 0.0667.
Suppose the broker requires a (initial) Margin account of Kshs. 350,000 and a
maintenance margin of Kshs. 300,000. The settlement prices for Monday through
Thursday are Kshs. 0.0680, Kshs. 0.0720, Kshs. 0.0650 and Kshs. 0.0640
respectively. On Friday, you close out the contract at a price of Kshs.
0.0652.
•
Calculate the daily cash flows on your account.
Describe any margin calls on your account. What is your cash balance with your
broker as of the close of business on Friday? Assume that you begin with an
initial margin of Kshs. 350,000 and that your round trip commission was Kshs.
10,000.
QUESTION 3
Kwetu Mbalizi plc is a company
operating in the USA which imports goods from Gwantwa
Mwakibibi in the UK. Kwetu
Mbalizi plc is due to pay £650, 000 to Gwantwa Mwakibibi on 20th
February 2017. It is now 12th November 2017.
The following futures contracts
(contract size £ 62, 500) are available on the Philadelphia exchange:
Expiry Current
Futures rate
December 1.4900$/£
March 1.4960$/£
(a)
Illustrate how Kwetu Mbalizi can use futures contracts
to reduce the transaction risk if, on 20th February, the sport rate
is 1.5030$/£ and March futures are trading at 1.5120$/£. The spot rate on 12
November is 1.4850$/£.
(b)
Calculate the hedge efficiency.
QUESTION 4
Show whether the following
options are in-the-money or out-of-the money?
(i)
A call option on 1,000 shares in TBL at a strike price
of Tshs.1, 275 when the current share price is Tshs.1, 153.
(ii)
A put option on 2,000 shares in TCC at a strike price
Tshs.630 when the current share price is Tshs.680
(iii)
A call option giving its holder the right to borrow
Tshs.500, 000, 000 for three months at a LIBOR rate of 4.5% when the current
LIBOR rate is 4.75%.
(iv)
A put option giving its holder the right to sell $100,
000 at $1 = Tshs. Tshs. 1200, when the spot exchange rate is $1 = Tshs 1, 180.
(v)
A call option on short dollar interest rate futures at
a strike price of 9, 450 when the current market price for the futures is 9,
625.
(b) The following are prices for
traded options in shares of Stanbic bank on October 2007 as shown below.
Nairobi
Traded options
Option Calls
Puts
Jan
Apr July
Jan
Apr July
Stanbic 300 30 40
50 10
15 20
*320 330 20 30 35
25
30 35
360
10 20
- 40
45 -
Date 20 October 2007
* Underlying current security
price
Notes
•
These option prices are for call options and put
options at three different strike prices, 300, 330, and 360 Kenyan Shillings.
•
With Nairobi traded options on shares at Nairobi
Stock exchange listed companies, each option contract is for 1,000 shares.
Required-
From the table of option prices
above, how much would it cost to buy?
(i)
Five April calls at a strike price of 330?
(ii)
Four July puts at a strike price of 300?
(iii)
What is the time value of the January puts at 360?
QUESTION 5
Rafiki Financial Consultants plc is
an international construction business that is based in the UK. The company
expects to receive €10 million in six months’ time as the final payment for a
bridge that the company recently completed in Germany.
The senior executives of the
company have been debating whether, and if so, how, to hedge against the
foreign exchange risk associated with the receipt.
The euro has been falling against
the £ sterling in recent months and some commentators believe that this trend
will continue. Others believe, however, that the euro is likely to strengthen
against the £ sterling in the near future as the euroland economies begin to
grow. Faced with this uncertainty, the company is considering three possible
options.
(i)
To take out a currency option to hedge against the
risk. An over-the-counter option is available from a bank at an exercise price
of £1 = €1·50 and at a premium cost of £1·20 per €100.
(ii)
To take out a forward exchange contract. Exchange rates
are:
£/€ spot 1·4904 – 1·4944
6 months forward €0·0095 – 0·0085 premium
(iii)
To do nothing.
Required:
(a) Show the effect of each of the
three options that are being considered, assuming that the exchange rate has
moved in six months’ time to:
(i)
£1 = €1·55
(ii)
£1 = €1·45 (8 marks)
(b) Discuss the
results from (a) above. (4 marks)
(c) Briefly
outline the main characteristics of currency options and forward exchange
contracts and explain the main advantages and disadvantages of each. (8
marks)
(Total 20 marks)
QUESTION 6
Gwakisa has recently commenced
exports to Kenya, a developing country and a former British colony. A payment
of 100 million shillings is due from a customer in Kenya in three months’ time.
The Kenyan government sometimes restricts the movement of funds from the
country, but has indicated that payment to Gwakisa has a good chance of
receiving approval. No forward market or derivatives markets exist for the
Kenyan Shilling in her country, but a colonial link between UK and Kenya
provides quotation for the pound and KSH respectively.
The Kenyan shilling is currently linked to the US dollar.
Exchange rates: KSH/£ $/£
Spot rate 126·4
– 128·2 1·775
– 1·782
3 month forward rate Not
available 1·781 – 1·789
Gwakisa can borrow at 6% per annum or invest at 4% per annum in the UK,
can borrow at 7% and invest at 4·5% in the USA, and at 14% and 10% respectively
in Kenya.
Gwakisa currently has a £800,000 overdraft in the UK.
Inflation rates:
UK = 3%, USA = 4%, and Kenya = 14%
Gwakisa’s Kenyan customer has
indicated that it might be willing to make a lead payment in return for a 1·5%
discount on the sale price.
Required:
(a) Discuss the advantages and
disadvantages of the alternative currency hedges (including relevant cross
hedges) that are available to Gwakisa. Calculate the expected outcome of each
hedge, and recommend which hedge should be selected.
(12 marks)
(b) Evaluate
whether or not Gwakisa should agree to its Kenyan customer receiving the 1·5%
discount. (4 marks)
(c) Suggest
possible action that Gwakisa might take if the government decides not to allow
the transfer of money out of Kenya. (4 marks)
(20 marks)
QUESTION 7
Kimoja Kitamu sana Co is a
UK-based company which has the following expected transactions.
One month: Expected
receipt of $240,000
One month: Expected
payment of $140,000
Three months: Expected receipts of $300,000
The finance manager has
collected the following information:
Spot rate ($ per £): 1.7820
± 0.0002
One month forward rate ($ per
£): 1.7829
± 0.0003
Three months
forward rate ($ per £): 1.7846 ± 0.0004
Money market rates for Kimoja
Kitamu sana Co
Borrowing Deposit
One year sterling interest
rate:
|
4.9%
|
4.6
|
|
One year dollar interest
rate:
|
5.4%
|
5.1
|
Assume that it is now 1 April.
Required:
(a) Discuss
the differences between transaction risk, translation risk and economic risk.
(b) Explain
how inflation rates can be used to forecast exchange rates.
(c) Calculate
the expected sterling receipts in one month and in three months using the
forward market.
(d) Calculate
the expected sterling receipts in three months using a money-market hedge and
recommend whether a forward market hedge or a money market hedge should be
used. (e) Discuss how sterling currency
futures contracts could be used to hedge the three-month dollar receipt.
QUESTION 8
(a) Mwanazuoni plc wishes to borrow $10 million in six months time
for a threemonth period. It normally borrows from its bank at LIBOR + 0.5%. The
current three-month LIBOR rate is 5.25, but the company is worried about the
risk of a sharp rise in interest rates in the near future.
A bank quotes FRA rates of:
3 v 6: 5.45 - 5.40%
6 v 9: 5.30 – 5.25%
(i)
How should the company establish a hedge against its
interest rate risk using an FRA?
(ii)
Suppose that at settlement date for the FRA, the LIBOR
reference rate is fixed at 6.5%. What will be the effective borrowing rate for
the company?
(b) It is early January. EPA a limited company intends to borrow £2
million in May for three months, and is concerned about the risk of rising
interest rates. It can borrow at LIBOR plus 1%.
The current
three-month LIBOR rate (spot rate) is 4.625%. June futures for short sterling
have a current market price of 95.35.
(i)
How should a hedge be set up for the exposure to the
risk of increase in the three-month LIBOR rate?
(ii)
Suppose that when the company does borrow £2 million in
May, threemonth LIBOR is 5.50% and the June futures price is 94.25? Calculate
the gain/loss from the interest rate futures contract
QUESTION 9
It is now March. Wajanja sisi plc
has recognized from its short-term cash budgets that it is likely to have a
surplus of £10 million arising in 2 months time (May) for a period of three
months, which it plans to invest in short-term money market instruments. It is
concerned that interest rates in the next 2 months may fall and wishes to hedge
this risk using futures contract.
June three-month sterling interest
rate futures contracts are available with a contract size of £500, 000. They
are currently priced at 96.00. Interest rates currently stand at 4%.
Required:
Illustrate how Wajanja sisi plc can
hedge its interest rate exposure using the above futures contracts if, in 2
months time, market interest rates have fallen to 3% and the futures price has moved
to 97.00
QUESTION 10
A company expects to borrow £4
million in two months time for a six month-period, and is thinking of using a
borrower’s option to hedge its risk. It is worried about the risk of an
increase in the three-month LIBOR rate, which is currently 5% per annum. It can
borrow at LIBOR plus 1%.
It normally buys a borrower’s
option at a strike rate of 5.25%, which has a premium cost of £8,000. The
option is for an expiry date in two months, and the notional interest period is
sixmonths and the notional principal is £4 million.
Suppose that at expiry, the six-month LIBOR is 6%.
Required:
Will the company exercise the option? How will a hedge be
constructed?
QUESTION 11
Yote Heri and Maisha safari
face the following interest rates (adjusted for the differential impact
of taxes)
Yote
Heri
|
Maisha Safari
|
||
US dollars (floating rate):
|
LIBOR
+ 0.5%
|
LIBOR + 1.0%
|
|
Canadian dollars (Fixed
rate):
|
5.0%
|
6.5%
|
Assume that Yote Heri wants to
borrow US dollars at a floating rate of interest and Maisha Safari wants to
borrow Canadian dollars at a fixed rate of interest. A financial Institution is
planning to arrange a swap and requires a 50-basis-point spread. If the swap is
equally attractive to Yote Heri and Maisha Safari, what rates of interest will
Yote Heri and Maisha Safari end up paying?
QUESTION 12
Dogodogo plc wishes to borrow US dollars at a fixed rate of
interest. Sisi kwa Sisi plc wishes to borrow Japanese yen at a fixed rate of
interest. The amounts required by the two companies are roughly the same at the
current exchange rate. The companies have been quoted the following interest
rates, which have been adjusted for the impact of taxes:
Yen
|
Dollars
|
|||||||
Dogodogo plc:
|
5.0%
|
9.6%
|
||||||
Sisi kwa Sisi:
|
6.5%
|
10.0%
|
Required:
Design a swap that will net a bank,
acting as intermediary, 50 basis points per annum. Make the swap equally
attractive to the two companies and ensure that all foreign exchange risk is
assumed by the bank.
Question 13
Differentiate and briefly explain the following terms as
used in derivative markets
a)
Futures contract Vs Forward contract
b)
Futures contract Vs Option contract
c)
Ticks, Interest rate futures, Variation Margin Vs
Initial Margin
d)
Call option Vs Put option, Intrinsic value Vs Time
value
e)
American option Vs European option
f)
Interest rate option, Swaptions, Interest rate cap,
Interest rate Floor and Interest rate collar options.
g)
Forward Rate Agreements (FRAs) Vs Forward Forwards
h)
Currency Swaps Vs Interest rate swaps
i)
Credit risk, Market risk and Sovereign Risk
Credit - Erick Lusekelo Mwambuli (Lecturer- Faculty of Accounting, Banking and Finance)
