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]
(b) Calculate DV01 for the DB02 bond. [2 marks]
(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]
(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]
(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]
(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 |
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|
Transaction Date
dd/mm/yy |
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Security Code |
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DB02 |
|
Issue |
|
Buy |
|
|
DB04 |
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Currency of Issue |
|
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DB06 |
|
Face Value |
|
|||
DB11 |
|
Coupon |
|
|||
US04 |
|
Yield % |
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US11 |
|
Spot Rate |
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EUR06 |
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AUD Proceeds |
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Signature |
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]
(b) You are required to calculate the portfolio generated cashflows. Note: The mid 3-month rate from last quarter (for the floating side of swaps) was 5.41% and there were 92 days in the quarter just completed. [4 marks]
(c) Calculate the net funding or investment requirement, including any impact from futures contracts. Clearly indicate whether the calculated amount requires funding or investment. [1 mark]
Question 3 (8 Marks)
The following figure is relevant to answer parts (a) to (d) of this question.
You are the manager of a large portfolio of liabilities comprising 90-day commercial paper, along with 3-, 6- and 10-year bonds. New advice suggests that the yield curve is likely to make a parallel upward shift as shown in the following diagram – a movement apparently not anticipated by the market.
Duration of portfolio
Yield
Time to maturity
(a) Outline how you would alter your portfolio to take advantage of the predicted move in the yield curve. Broadly, what will be the impact of this portfolio restructuring on the portfolio duration. [2 marks]
(b) Outline how you would use futures to take advantage of the predicted move in the yield curve. Assume that both 3- and 10-year bond futures are available to you. [2 marks]
(c) Outline how you would use a swap to take advantage of the predicted move in the yield curve. Assume that the following swap instruments are available. The applicable interest rate for the floating side of the swap is 5.02%. Today is March 15, 2002.
Instrument Coupon Maturity Swap rates
IRSDB04 5.70% 15-09-04 5.66/5.70
IRSDB06 5.95% 15-09-06 6.02/6.06
IRSDB11 6.25% 15-09- 11 6.46/6.50
[2 marks]
(d) Would a widening of swap spreads make you more or less inclined to use a swap in the situation described above? Explain. [2 marks]
Question 4 (4 Marks)
(a) Detail the various cashflows (and their timing) associated with using futures contracts in the trading game. [2 marks]
(b) In the trading game, a deposit margin of $700 was required for the 3-year futures and $2,000 for the 10-year futures. Why are different amounts required for the different futures contracts? [2 marks]
Question 5 (2 Marks)
Describe a situation in the trading game where you might choose to both a 10-year bond futures contract and at the same time, sell a 3-year bond futures contract. What would be the impact of these trades on the portfolio duration?
Question 6 (7 Marks)
(a) Assume that the following swap instruments are available. The applicable interest rate for the floating side of the swap is 5.02%. Today is March 15, 2002 and there are exactly 90 days between now and the end of the quarter in June.
Instrument |
Coupon |
Maturity |
Swap rates |
IRSDB04 |
5.70% |
15-09-04 |
5.66/5.70 |
IRSDB06 |
5.95% |
15-09-06 |
6.02/6.06 |
IRSDB11 |
6.25% |
15-09- 11 |
6.46/6.50 |
Required: Calculate the market value of an IRSDB06 swap that has a $1,000,000 face value. If you are paying fixed and receiving floating, does the swap have a positive or negative value to you? Will the swap involve a net cash inflow or outflow for you today? [4 marks]
(b) Draw a deal slip similar to the one given below on the answer booklet. Then, complete the deal slip to create the swap transaction in part (a). You must answer on the answer booklet provided, and clearly label all the rows (i.e., pay/receive, currency, face value etc) and columns (i.e., Fixed or Floating). [3 marks]
Question 7 ( 1 1 Marks)
Assume that you manage the commodity and foreign exchange hedging needs of several clients. One of your clients has contracted to purchase 500 tonnes of copper in nine months (15/3/02) and has asked you to manage the commodity and foreign exchange risk associated with this transaction. The following table provides data on the current (15/6/01) commodity and foreign exchange prices.
Maturity |
Exchange Rates USD EUR |
Commodity Prices Copper/tonne |
|
Spot Rate (Call) 3 months 6 months 9 months 12 months |
0.4952/0.4956 0.0001/0.0002 0.0006/0.0008 0.0007/0.0010 0.0010/0.0014 |
0.5555/0.5559 -0.0013/-0.0012 -0.0020/-0.0018 -0.0032/-0.0029 -0.0042/-0.0037 |
US$2,023/2,028 US$2,036/2,041 US$2,041/2,046 US$2,046/2,051 US$2,044/2,049 |
(a) New economic advice suggests that the current strong economic growth may soon come to an end. Consumer confidence has fallen sharply, retail spending is down on prior periods and manufacturers are beginning to report a build-up in inventories. As a result, copper prices and the Australian dollar are expected to weaken. Given this advice, which one of the following transactions should you undertake for your client? Cleary explain your answer.
(i) Buy 500 tonnes of copper with March 2002 delivery
(ii) Buy Euros with March 2002 delivery
(iii) Buy USD with March 2002 delivery
(iv) Sell USD with March 2002 delivery [2 marks]
(b) Assume you now decide to fully hedge both the commodity price risk and foreign exchange risk . What is the dollar value you would enter on a commodity deal slip to establish the required hedge? Show all working. [2 marks]
(c) Assume you now decide to fully hedge both the commodity price risk and foreign exchange risk . What is the exchange rate and Australian dollar amount that you would enter on a foreign exchange deal slip to establish the required hedge? Show all working. [ 1 mark]
(d) As well as handling the hedging needs of your clients, you also speculate on the commodity and foreign exchange markets. You must take a speculative position in the commodity markets that will profit if the economic advice provided proves to be correct. Assume your commodity transaction is for 100 tonnes of copper and the maturity date of the transaction is 15/9/01. What is the copper price that you would enter on the deal slip? [2 marks]
(e) As well as handling the hedging needs of your clients, you also speculate on the commodity and foreign exchange markets. You must take a speculative position in the foreign exchange market that will profit if the economic advice provided proves to be correct. Assume your foreign exchange transaction is for US$1m and the maturity date of the transaction is 15/12/01. What is the exchange rate you would enter on the deal slip? [2 marks]
(f) On the bottom of page 3 of a typical team performance report, there is a ‘Commodity and Foreign Exchange’ section. This section shows the saving achieved on behalf of clients. Explain how the saving is calculated. [2 marks]
2022-06-15