FINM7405 Financial Risk Management 2019
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Semester One Sample Examinations, 2019
FINM7405 Financial Risk Management
Question 1 ( 10 Marks)
The following table is relevant to answer parts (a) to (c) of this question.
Assume you manage the following portfolio of liabilities.
Instrument |
Coupon |
Maturity date |
Face Value ($m) |
Market Value ($) |
Market Interest rate |
Macaulay Duration |
DB02 |
5.20% |
15-03-02 |
100 |
100,077,029.60 |
5.08/5. 12 |
? |
DB11 |
5.65% |
15-03- 11 |
100 |
100,607,102.57 |
5.53/5.57 |
7.77 |
Note: Today is the 15th March 2001 and there are 92 days between today and 15th June 2001. The DB02 market value is based on 5. 12% yield and DB11 market value is based on 5.57% yield.
(a) Assume that the $100m of DB02 in the table above was issued today to an institutional investor called BondBuy Ltd. If BondBuy holds the DB02 until maturity, what percentage return will BondBuy have earned on its investment for the one year holding period?
[1 mark]
If BondBuy holds the DB02 to maturity, they must earn the market yield prevailing on the bond at the time of purchase – ie. 5.12% compounded semi-annually. In this case, as in the game, we assume that we issue the bond at the worst rate to us 5.12%. Thus, the buyer receives 5.12%.
(b) Calculate DV01 for the DB02 bond.
[2 marks]
t |
cash flow |
PV |
weight |
t x weight |
0.5 |
2600000 |
2535101.4 |
0.025332 |
0.012666 |
1 |
102600000 |
97541928 |
0.974668 |
0.974668 |
|
|
100077030 |
|
0.987334 |
PV for first row = 260000 (1+0.0512/2)-0.5*2
Weight for the first row = 2535101/100077030
Macaulay duration = 0.9873
Modified duration = 0.9873/(1+0.0512/2) = 0.9627
DV01 = 0.9627 * market value * 0.0001 = 0.9627 * 100077030* 0.0001 = 9634
(c) Today (15th March 2001) you receive a highly regarded economic forecast of interest rates in three months. The rate forecast for DB02 is 4.88/4.92 and the rate forecast for DB11 is 5.48/5.52.
(i) Use the duration to estimate the expected change in the dollar value of the DB02 and DB11 liabilities that you manage.
[2 marks]
DB02:
We forecast a change from 5.12% to 4.92%; this is a drop of 20 basis points Thus, a 20bps drop will produce 20 * DV01 = 20*9634=$192686 increase in DB02
DB11:
We forecast a change from 5.57% to 5.52%; this is a drop of 5 basis points Thus, a 5bps drop will produce 5 * DV01 = 5*76061=$380,305 increase in DB11
Where modified duration for DB11 = Macaulay duration/(1+yield/2) = 7.77/(1+0.0557/2) = 7.56 and DV01 for DB11 = 7.56*100607103*0.0001 = 76061
(ii) Calculate the cost of funds for DB02 over the period 16th March 2001 to 15th June 2001
(assume DB02 yield in June is equal to the forecast of 4.88/4.92) .
[2 marks]
• The cost of funds is equal to the return achieved by an investor who held the bond over that 3 month period.
t |
cash flow |
PV |
0.25 |
2600000 |
2568598.2 |
0.75 |
102600000 |
98927226 |
|
|
101495825 |
In the first row, the time interval between 15 June 2001 and 15 Sept 2001 (which is the coupon date of DB02) is 0.25. Hence, the PV = 260000 (1+0.0492/2)-0.25*2
In the second row, the time interval between 15 June 2001 and 15 Mar 2002 (which is the maturity of DB02) is 0.75. Hence, the PV = 10260000 (1+0.0492/2)-0.75*2
Thus, the price in June is $101,495,825
• The price in March is $100,077,030 and in June is $101,495,825.
• The annualized cost of funds is therefore: ($101,495,825/$100,077,030-1) X 365/92 = 5.63%
Note: The question assumes 92 days between March 2001 and June 2001.
(iii) Assume that you are required to raise $150mil today for a client. Which bond (DB02 or
DB11) should you issue to raise the required funds? (Note: you can ignore any management ranges that would normally apply in the trading game)
[ 1 mark]
• The answers from c(i) and c(ii) suggests that the highest cost of funds will reside in the DB11 bond, given that the dollar value increase (i.e., liability value increases) is around double that of DB02.
• Therefore, we should use DB02 to raise the funds (because the increase in the liability value of DB02 is relatively smaller).
(iv) Draw a deal slip similar to the one given below on the answer booklet. Then, in respect
of the bond issued in part (c. iii), complete the deal slip. Ensure that you raise exactly the $150mil as required.
[2 marks]
BOND TRANSACTION ADVICE |
||||||
|
Transaction Date
dd/mm/yy |
|||||
Security Code |
||||||
DB02 |
X |
Issue |
X |
Buy |
|
|
DB04 |
|
Currency of Issue |
AUD |
|||
DB06 |
|
Face Value |
$149,884,544.53 |
|||
DB11 |
|
Coupon |
5.20% |
|||
US04 |
|
Yield % |
5. 12% |
|||
US11 |
|
Spot Rate |
|
|||
EUR06 |
|
AUD Proceeds |
$150,000,000.00 |
|||
Signature xxxxxxxxxxxxxxx |
Note: face value to raise $150M is:
100,000,000/100,077,029.6*150,000,000=$149,884,544.53
Question 2 (8 Marks)
Today is the 14th September 2001 (the last day of Quarter 2) and, as the manager of a large portfolio of liabilities, you need to determine the funds to be raised or invested on the first day of Quarter 3 (tomorrow). Other information that may be relevant to this calculation includes:
• Two of your clients (QEPA, APA) will each make a one-off repayment of $10m tomorrow.
• Another client (LG) requires an advance of $15m tomorrow and this follows an advance of the same amount on the 15th June (at 5.60% for three years).
• Tomorrow, LG will also pay an overseas supplier US$5M (AUD10M) for the supply of raw materials for a new infrastructure project .
• At the start of the year (15th March) your clients made the following debt service payments:
o QEPA: $1.45m
o LG: $2.05m
o APA: $4.63m
Note: these quarterly debt service payments are scheduled to continue for at least the next two years.
• No futures contracts were bought or sold in June. However, you plan to buy 200 ten year futures contracts tomorrow. The deposit margin is $2,000 per contract and brokerage is $5 per contract payable in arrears.
• At the start of the current quarter, you issued commercial paper with face value of $170m . The face value and coupon of bonds currently on issue is: DB02 ($150m/5.2%); DB04 ($100m/5. 1%); DB06 ($300. 1m/5.3%); DB11 ($245m/5.65%). There are two pay fixed, receive floating domestic interest rate swaps on issue with face value and coupon: IRSDB04 ($50m/5. 1%); IRSDB11 ($125m/5.65%). Also, on issue is one $US denominated eurobond (US11) with face value and coupon of $US55m/6% and one $Euro denominated eurobond (EUR06) with face value and coupon of $EUR58.75m/5%. Both eurobonds have been swapped back into domestic CP3M with a face value of AUD200m .
• Coupons are paid in March and September
• The market value of the portfolio on the 15th June was $1,107,534,373 and the administration charge is 0.50% per annum .
• Assume that there are no debt service payments other than those mentioned or implied above.
(a) Calculate the net client cashflow that will occur on the first day of the new quarter (tomorrow). Clearly show all calculations and cashflows.
[3 marks]
Write your answer here:
Client Cashflows
Advance (LG) -
Repayment (QEPA)
Repayment (APA)
DSP (QEPA)
DSP (LG)
DSP (APA)
DSP (Qtr 2 advance to LG)
15,000,000
10,000,000
10,000,000
1,450,000
2,050,000
4,630,000
1,366,648
14,496,648
15,000,000
= 1 − (1 + 5.6%4) −12
5.60%
PV = A 1 − (1 + r) − n
r
2022-06-11