Question No 1

a.         Advantages of futures contracts (inter-alia):

•   limited counter-party credit risk due to the system of margining.

•   centralised trading reduces search costs.

•   standardisation of contracts minimises negotiation costs.

•   may have the ability to offset or settle by cash difference. This eliminates the need to make or take delivery of the underlying asset.

•   Greater liquidity, where contracts are traded through a recognised exchange (compared to “over the counter” contracts in the forward market).

Question No 2

a. Use the Sept 90 day bank Bill contract. Reason: Choose the contract as close as possible but after the hedge target period (the hedge target period is 1 July 2021).

b.   Use the Sept 90 day bank Bill contract. Price =  = 3.75% = 0.0375

Value per contract     =  = 990,838. 14

Amount if bills issued today =    = 263,686,754.58

i.e.       Long  =  = 798.38

= 798 Long 90-day Sept BBCs

c.    Long Sept 90 day Bank Bill futures contracts. An investor is concerned that interest rates will fall. If rates fall, then the profit on the futures position will offset the higher ‘investment” cost (when interest rates are lower) of the 270 day bank bills.

Question No 3

a.         What are the fair forward price and initial value of the forward contract?

Answer

i = 0.09/12 = 0.00750 = 0.75%

c.c rate = 12 ln(1+0.09/12) = 8.97%.

F

=

=

I     =

=

(continuous compounding)

(simple interest compounding)

F    =    (80 – 1.912) (1 + .09/12)12

=     $85.41 (i.e. forward price)

and initial value of forward contract f = 0

.

Answer

c.c rate = 12 ln(1+0.06/12) = 5.99%.

f

=

=

=

(F-K)e-rT

(86.40 – 85.41) / (1 + .06/12)8

0.95

and as the investor is long the value of their position = 0.95

Question No 4

.

i.e. duration of two-year bonds is 1.456 years

.

B = $24,484,717.38

F = $100,000

N* = (B/F) * (DB/DF) = ($24,606,855.88 /$100,000) * (1.456/2.726) = 131.46 i.e. fund manager needs to sell 131 bond futures contracts.

c.   Short or sell

Question No 5

a.

F = 1050 exp (0.075 *6/12) = 1090.12

b.

Take a short position in the futures market in the amount:                                         (-0.4 - 1.2)*(100000*125)/(1000*1090.12)=- 18.35 contracts (round to 18 contracts)

Wrong answer but partial marks

(-0.4 - 1.2)*(100000*125)/(1000*1050) = - 19.05 contracts (round to 19 contracts)