Financial Institutions Instruments And Markets 9th Edition Peter J. Phillips; Christopher Viney - Solutions

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A US-based company and a Ukraine-based company are negotiating a direct cross-currency swap. They have identified that it is possible to take advantage of a net borrowing differential in order to lower net borrowing costs by 50 basis points. However, in the end, the board of directors of the
Bloomberg reported in 2018 that ‘Nigeria and China agreed on a cross-currency swap worth $2.4 billion to boost commercial ties and reduce the need to use the dollar in bilateral trade’. Explain how a cross-currency swap can help these two parties achieve this goal. (LO 21.3)
The spread (difference) between the swap rate and the yield on Treasury securities usually shows a premium in favour of the swap rate. In the USA, this relationship became inverted during 2015 and remained that way until the end of 2017. Explain how demand for interest rate swaps in a low interest
In 2018, the Financial Times carried an article entitled, ‘Time to wipe out the absurd credit default swap market’. The article contained the argument that CDS do not actually offer protection against default risk because the ‘event triggers’ can never be agreed upon in practice. In
On the basis of the data provided below, and with the knowledge that company P wants to borrow AUD50 million paying a variable interest rate, and that company Q wants to borrow USD30 million paying a fixed interest rate, construct a cross-currency swap. Use diagrams to support your answer.(a)
As the treasury sales executive for the National Bank, you approach two of your multinational clients and offer to construct a cross-currency swap that will enable both clients to manage their interest rate and foreign exchange rate risk exposures on their current debt issues.Company J has borrowed
Explain the circumstances under which the parties to a cross-currency swap are not exposed to foreign exchange risk. (LO 21.3)
Outline the main features of a cross-currency swap. Include in your answer a discussion of the differences between an interest rate swap and a cross-currency swap. (LO 21.3)
Critically evaluate the assertion that under a fixed-to-floating interest rate swap, the party paying variable interest rates loses when the floating rate exceeds the fixed rate. (LO 21.2)
‘With reduced opportunities for the profitable arbitraging of interest rate differentials between borrowers in different markets, swaps have increasingly been used to facilitate the restructuring of borrowers’ existing debts.’ Discuss and explain this statement. (LO 21.2)
You work at the interest rate swaps desk of the treasury division of Mega Bank. Two companies have approached the bank, each seeking to enter into a $1 million intermediated interest rate swap. You have ascertained the following information in relation to the borrowing capacity of each company:Debt
The data below show the rates at which firm X and firm Y are able to borrow in the fixed- and variable-rate debt markets.Prepare a fully labelled diagram to show the construction and cash flows of the direct interest rate swap. In your diagram, show which firm will initially borrow fixed-rate debt
(a) Given the data provided below, state whether a profitable swap may be arranged in both situation 1 and situation 2. In your answer calculate comparative advantages and show the net borrowing differential that may be gained.(b) Within the context of an interest rate swap, explain why the
(a) Explain the concept of ‘comparative advantage’ as it applies to the cost of fixed interest rate and variable interest rate debt between different borrowers.(b) Does comparative advantage always need to be split equally between the two parties?Explain your answer. (LO 21.1)
(a) A trader expects interest rates to increase. Rather than take a position in the bond market, the trader decides to use interest rate swaps to carry out the trade. What position would a trader with this set of expectations take in the interest rate swaps market?(b) How would the trader’s
A corporate treasurer is concerned at the high cost of the premium associated with establishing an options strategy. The company’s bank suggests that the use of a barrier knock-out option to protect against a rise in the spot exchange rate might be a cheaper alternative strategy.(a) Explain how a
There is an expectation of increasing price volatility in the market due to the uncertainty surrounding the winding back of the stimulus programs and expansionary monetary policies that were put in place during and after the GFC. Design an options strategy that will enable a profit to be locked in,
(a) In what circumstances might an investor consider a vertical bear spread option strategy?(b) Discuss the construction of the strategy and draw the relevant profit profiles. (LO 20.5)
An investor has a quite bullish view that prices in the share market will rise, but is concerned that there is still some risk that prices might fall. Draw and explain the relevant profit profiles for a call bull spread strategy for (a) the holder of a call option, (b) the writer of a call option
A company knows that it will need to borrow $500000 in six months’ time and is concerned that interest rates may rise before that date. The company wishes to protect itself against a rise in interest rates and decides to use an options collar strategy. Explain how a collar strategy is structured
During periods of market distress, investors’ risk aversion increases and implied volatility in the options markets moves higher to reflect declines in the physical markets and the increased uncertainty confronting investors (when people are more risk averse, they will pay more to protect or
Discuss the relationship between the exercise price of an option, the current market price of the underlying asset and the intrinsic value of the option. In your answer, explain the money position of an option. (LO 20.4)
One of the categories of options available to investors and speculators is LEPOs. Assuming 7.00 per cent margin, what would be the percentage return and dollar profit to an investor who purchased one LEPO (for 1000 shares) for a premium of $26220 and later closed out the position when the LEPO
(a) Options exchanges tend to specialise in certain option contracts. Discuss this statement within the context of the international options markets.(b) Option contracts may be traded by open outcry or through electronic trading systems.Briefly explain each of these methods used for trading option
A speculator has written an option on the shares of Sonic Healthcare.(a) Discuss the differences between a covered option and a naked call option.(b) What requirements will be applied by an options exchange to ensure that the option writer can meet the contract obligations? (LO 20.2)
Wesfarmers shares currently trade at $43.00. A fund manager is holding a large number of Wesfarmers shares in an investment portfolio and wishes to protect the value of the investment.The manager buys a long put option with an exercise price of $42.50 per share and pays a premium of $1.30 per
Aurizon Holdings Limited shares currently trade at $5.21. An investor enters into a long-call option on Aurizon with an exercise price of $5.80 per share in four months, and a premium of$0.28 per share.(a) Calculate the break-even price for the short-call position.(b) Draw a fully labelled diagram
Explain why American options will usually have a higher value than European options, even when all of the other features (strike price, expiry date, etc.) are the same. (LO 20.1)
In what ways are option contracts more flexible than futures contracts? (LO 20.1)
With reference to the relationship between stock prices and options values, explain what boards of directors are trying to achieve when they award CEOs options as part of their executive compensation packages. (LO 20.1)
You know that in seven months’ time your company is going to borrow $5 million for six months.You obtain the following quotes from an FRA dealer:6Mv7M(23) 10.35 to 25 7Mv13M(23) 10.50 to 20 You enter into an FRA with the dealer:(a) What will be the FRA agreed rate?(b) If the reference rate on the
(a) What is a forward rate agreement?(b) What are the main features of an FRA? Explain how a corporation that needs to borrow funds in seven months can use an FRA to fix the cost of funds today.(c) What are the main differences between an FRA and a futures contract? (LO 19.7)
(a) Define the forms of basis risk and explain why it is important for a hedger to understand this risk prior to dealing in derivative products. Use examples to explain your responses.(b) When hedging risk, what is cross-commodity risk? In your answer, provide examples to explain cross-commodity
While financial futures contracts may be used to hedge the risk of fluctuations in the prices of the underlying securities, the use of futures contracts often entails some risk. What are the sources of risk arising from the use of futures contracts in risk management? List, explain and demonstrate
A fund manager currently holds a well-diversified portfolio of Australian shares valued at$250000000. The global political context is unstable and the fund manager anticipates a period of unusually high market volatility. The S&P/ASX 200 VIX currently stands at 22. The S&P/ASX 200 Index stands at
A fund manager currently manages a diversified Australian share portfolio valued at $250 million.The manager decides to use the S&P/ASX 200 Index futures contract to manage an exposure to a forecast decline in share prices. The S&P/ASX 200 Index is currently at 5500. In three months’ time the
A fund manager forecasts that it will need to invest $100 million in approximately 90 days.The manager wishes to receive a return as close as possible to the medium-term interest rates currently available, but expects that rates will have fallen by the time the funds are available for
A business plans to borrow approximately $40 million in short-term funding through the issue of commercial paper in three months’ time. The business does not have a view on what is likely to happen to interest rates over the next three months, but it would be very satisfied if it could obtain its
Distinguish between hedgers and speculators. Show how a hedger could use 90-day bankaccepted bill futures contracts to hedge interest rate uncertainty. Show how a speculator may use the same futures contracts in an attempt to make a profit. (LO 19.4)
‘In 2017, the average daily turnover in the Australian bond futures markets was 207000 contracts for the three-year and 162000 for the 10-year. This indicates an undesirably high level of speculation in the bond futures markets in Australia.’ Discuss the validity of this statement. (LO 19.2)
On ASX Trade24 the quotation of the three-year Treasury bond futures contract is such that traders can easily follow a ‘buy low sell high’ rule. Construct an example that shows how this works. (LO 19.2)
(a) Outline the procedure involved in buying a futures contract.(b) Indicate the implications of being long in a futures contract.(c) Indicate the implications of being short in a futures contract.(d) What are the procedures for closing out these positions prior to delivery? (LO 19.2)
For investors and borrowers considering setting up a risk management strategy using futures contracts, there is a basic rule that determines the timing of the various buy/sell transactions.Specify and explain this rule, giving examples from an investor’s and a borrower’s viewpoint.(LO 19.2)
Explain why it is not usually possible to perfectly hedge a position using futures contracts. (LO 19.2)
Oil Search notes in its annual reports that it is exposed to the risk of falling oil prices, increasing interest rates and changes in the exchange rates of various foreign currencies. How can Oil Search use derivative products to manage these risks? (LO 19.1)
A state government borrowing authority is to issue USD bonds as part of the government’s capital funding program. The borrowing authority plans to establish an intermediated crosscurrency swap in order to convert the USD principal amount raised into AUD and, at the same time, manage the FX risk
Iluka Resources has recently issued $15 million in floating rate notes in order to fund the next stage of an exploration project. The notes pay an annual coupon of BBSW plus 150 basis points. The company approaches Commonwealth Bank to establish an intermediated vanilla swap. The swap contract sets
A superannuation fund is holding a large number of National Bank Limited shares in an investment portfolio and wishes to protect the value of the investment. The shares currently trade at $24.49. The superannuation fund buys a put option with an exercise price of$24.00 per share and a premium of
Dexus Property Group shares currently trade at $9.10. An investor enters into a call option on Dexus shares with an exercise price of $9.30 per share in two months, and a premium of$0.25 per share.(a) Define an option and explain the premium and the exercise price.(b) What is a call option?(c) Draw
An importer has entered into a USD contract that will require payment of USD10 million in one month. The importer wishes to lock in an exchange rate today in order to protect its future profit margins. An investment bank gives the following quote: AUD/USD0.7340–33 12:17. Calculate the
Pacific Brands has established a $5 million 90-day bank bill rollover facility with ANZ Bank.The company is concerned that interest rates may rise at the next rollover date. The company decides to manage this risk exposure with a forward rate agreement (FRA) with ANZ. The bank gives the following
At the completion of a futures contract risk management strategy, a risk manager will have made either a profit or a loss on the futures market transactions.(a) How was the profit or loss in the futures market derived?(b) Explain how making a loss with the futures market strategy can result in the
With two business partners, you manage a small financial services firm that actively manages$40000000 in superannuation funds. The markets have been particularly volatile and your analysis suggests that there is a strong chance of a significant market correction in the short to medium term. Explain
Your financial adviser argues that you should take a position in the futures market that is the opposite of the position you have in the physical market. You are a farmer with wheat growing in the field. Should you take buy or sell wheat futures if you are worried about price declines between now
The analysis of risk exposures is an important part of a structured risk management process.(a) Outline the main features of risk analysis in the risk management process.(b) What are some of the challenges that confront risk analysts? (LO 18.2)
According to CSL Limited’s statements: In 2017, the Board and Global Leadership Group adopted an internal ‘Risk Appetite Statement’, to be implemented throughout the CSL Group.CSL’s risk appetite is integral to the company’s overall risk management processes and the Risk Appetite
Macquarie Bank relies upon its online trading platforms and communication systems to execute trades and maintain communication with customers.(a) What category of risk best defines this type of risk exposure?(b) Within the context of internal and external risk management, briefly discuss how the
Standard deviation and variance are two statistical measures for dispersion. They can be used to determine how variable or volatile a series of data is. Your best friend, Barry Markowitz, has argued that risk can be measured using either of these statistics. That is, if you want to know how risky a
Heritage Bank is a medium-sized financial institution headquartered in Toowoomba, Queensland, Australia. Heritage has existing bonds on issue and is seeking to raise additional capital by a further bond issue. As global economic and political uncertainties abate, the treasury management team at
Risk management is important to the long-term survival of a corporation.(a) Define and explain the nature of risk.(b) What is the purpose of risk management?(c) Discuss who is responsible for the establishment of risk management objectives, policies, procedures and strategies in a corporation. (LO
Identify and discuss eight internal hedging techniques that might be used by a firm to minimise FX exposures. Include in your discussion the advantages and disadvantages associated with each type of technique. (LO 17.4)
Explain how an Australian company could hedge its net HUF (Hungarian forint) payables using a BSI money-market hedging strategy. Illustrate your answer based on the company having a HUF200 million payable due in 180 days. Assume a spot rate of AUD/HUF206.90–99, a Hungarian interest rate of 8.00
An Australian company is exporting electronic components to Sweden. The company has a receivable of SEK10000000 (Swedish krona) due in three months’ time. The company approaches its bank and enters into a forward exchange contract. Rates are quoted as AUD/SEK6.16–19, forward points 8–5.
Describe in conceptual terms how a company could hedge its net foreign currency receivables using a forward exchange contract. (LO 17.3)
Explain how foreign currency standard deviations and currency correlations may assist in assessing the risk associated with a company’s FX exposures. In your answer consider the strengths and weaknesses of these measures. (LO 17.2)
FX risk may be said to be two-directional. Within the context of a company borrowing in the international capital markets, explain the two-directional nature of FX risk, having regard to the ongoing cash flows associated with the debt facility. (LO 17.2)
Discuss why a company should calculate its time-specific net cash-flow exposures in each foreign currency rather than simply listing all foreign currency transactions in order to assess its FX risk exposure. (LO 17.2)
As a result of recent high-profile corporate failures, the board of directors of a company is reviewing its FX policy document in relation to FX audit functions. Identify and explain important issues that the company must incorporate in its policy document in relation to the FX audit function. (LO
‘Performance evaluation provides management with a valuable tool in the management of FX risk exposures.’ Discuss and explain this statement. (LO 17.1)
In order to ensure that appropriate controls are in place, the board of directors will make certain that the FX policy document covers authorisations and exposure reporting systems. What issues relating to authorisations and exposure reporting systems should be included in the policy document?
The FX policy document of an organisation will include the FX objectives and management structure that will apply to the organisation. Discuss issues that you would expect to be incorporated in that part of the FX policy document. (LO 17.1)
Google, an American company, is investing heavily in data-centres in Finland. Each centre is expected to generate cash flows in the cloud computing space. Google has evaluated the project in US dollar terms at the prevailing USD/EUR exchange rate. With reference to economic FX exposure, outline the
Exposure to FX risk is a significant factor that must be considered when a company decides whether to raise funds in the international capital markets. Explain how a company that has borrowed overseas in USD might be affected if the local currency depreciates. (LO 17.1)
In 2017, the Sydney Morning Herald carried the provocative headline: ‘Aussie dollar strength a“phantom menace” for overseas earners’. The ensuing article refers to a stock-market sell-off of Australian companies exposed to USD earnings. Explain why exposure to USD earnings could lead to a
Wesfarmers is one of Australia’s largest companies. On its website, it states the following in reference to FX risk management:The Group’s policy is to protect the Group from currency fluctuations together with maintaining the integrity of business decisions and protecting the competitive
While the PPP theory has stood the test of time, it must be recognised that it has some identifiable inadequacies. List and explain the inadequacies of the PPP theory within the context of exchange rate determination. (LO 16.4)
Briefly outline the basic contention of the purchasing power parity theory of exchange rate determination. (LO 16.4)
A market-determined exchange rate is affected by changes in relative inflation, relative national income growth rates, relative interest rate differentials, government or central bank intervention, and market expectations. Regression analysis is a statistical technique used in the analysis of
The Reserve Bank of Australia has not intervened in the FX markets for more than a decade.Why are interventions so rare? What could prompt an intervention in the future? (LO 16.2)
Participants in the FX markets actively attempt to forecast changes in economic variables that should impact upon future exchange rates. Therefore, it may be argued that exchange rate expectations are of critical importance in determining the FX value of a currency.(a) Identify and discuss factors
Consider the data in the two scenarios in the table below.Scenario i AUD (%) i USD (%) Expected change in value of AUD (%) 1 5 2 −4 2 2 5 +4(a) Under which scenario will an investor in the USA consider investing funds in the Australian money markets? Explain why this is so.(b) Also, explain why
Each of the following statements has been put forward as an explanation of exchange rate movements.• ‘The increase in the value of a currency is because rates of interest in that country have risen relative to those in the rest of the world.’• ‘The decrease in the value of a currency is
Draw a chart and explain in words what is expected to happen to the Indonesian rupiah demand and supply curves (USD/IDR) if there is a forecast increase in Indonesia’s interest rates relative to interest rates in the USA. (LO 16.2)
Consider the following apparently contradictory statements:• ‘An increase in the rate of growth in a country’s national income relative to that in the rest of the world will result in a depreciation of that currency.’• ‘An increase in the rate of growth in a country’s national income
Draw a chart and explain in words what is expected to happen to the New Zealand dollar demand and supply curves (USD/NZD) if there is a forecast increase in New Zealand’s national income relative to a stable growth rate in the USA. (LO 16.2)
Draw a chart and explain in words what is expected to happen to the Indian rupee demand and supply curves (USD/INR) if there is a forecast increase in India’s inflation rate while the inflation rate remains stable in the USA. (LO 16.2)
The Reserve Bank of Australia sometimes intervenes in the FX markets.(a) Discuss the importance of the RBA trading under its own name during these periods.(b) What is the rationale for the RBA targeting its interventions in the AUD/USD exchange market? (LO 16.2)
Under a floating exchange rate regime, the exchange rate will always adjust so that the demand for, and the supply of, a currency in the FX market will be equal.(a) Having regard to this statement, describe the mechanisms through which equilibrium is maintained in the event of a change in the
Draw a graph that depicts the AUD/EUR demand curve and supply curve. Plot the equilibrium exchange rate at AUD/EUR0.7000. If the spot exchange rate is AUD/EUR0.7500, what impact will that have on the demand and supply position in the FX markets? (LO 16.1)
The Reserve Bank of Australia publishes an index of commodity prices. Outline the nature and purpose of this index and explain how it can help us to forecast changes in the equilibrium value of the Australian dollar. (LO 16.1)
Mega Bank is conducting a review of its interest rate risk exposures associated with its loan portfolio. Once the bank has identified and measured its potential exposures to interest rate risk, it will investigate a range of internal and external risk management techniques that may be used to
Unsecured notes issued by Woodside Petroleum Limited have a face value of $1 million and pay an annual coupon of 9.65 per cent per annum. The note matures in exactly two years.Current yields on this type of security are also 9.65 per cent per annum.(a) Use duration to calculate the price of the
A fund manager is holding fixed-interest bonds with a face value of $4750000. The bonds pay an annual coupon of 6.00 per cent per annum and will mature in exactly three years.The fund manager has forecast that interest rates will rise by 50 basis points. Based on the forecast change in interest
Fixed-interest fund managers measure convexity in conjunction with duration to better measure their exposures to interest rate risk. Discuss the concept of convexity within the context of interest rate risk measurement, duration and the bond price–yield curve. (LO 14.4 and 14.6)
Duration is a useful risk measurement tool that is commonly used by fixed-interest portfolio managers. However, duration suffers from a number of limitations. Identify and discuss the limitations associated with using duration to measure interest rate risk. (LO 14.6)
Listed below is a simplified balance sheet showing the dollar value and duration of assets and liabilities held. For ease of calculation, we will assume an average interest rate of 6.00 per cent per annum; that is r = 0.06.(a) Calculate the duration of the asset portfolio and the duration of the
The holder of a $100000 debenture issued by BHP Billiton is concerned that the value of the debenture will change if interest rates rise. The debenture pays a fixed annual coupon of 8.25 per cent per annum and has exactly three years to maturity. Current market yields are 8.50 per cent per
A major bank is to sell securities from an existing security portfolio to ensure it has sufficient liquid funds available over the next one-month planning period. The bank wishes to sell the group of securities with the higher interest rate risk. Using the data below:(a) Calculate the duration of
A large funds management organisation offers investors a specialist fund that invests mainly in fixed-interest securities. The fund manager finds duration a particularly useful tool for measuring the fund’s exposure to interest rate risk. Define duration and explain why it is so useful for
A regional bank uses re-pricing gap analysis as its main interest rate risk measurement tool.Each month, the bank generates a report that categorises assets and liabilities by the interest rate sensitivity over a one-month planning period. The latest report is shown below:(a) Calculate the current

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Financial Institutions Instruments And Markets 9th Edition Peter J. Phillips; Christopher Viney - Solutions

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