(a) XYZ Limited borrows 15 Million of six months LIBOR + 10.00 % for a...

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(a) XYZ Limited borrows £ 15 Million of six months LIBOR + 10.00 % for a period of 24 months. The company anticipates a rise in LIBOR, hence it proposes to buy a Cap Option from its Bankers at the strike rate of 8.00%. The lump sum premium is 1.00% for the entire reset periods and the fixed rate of interest is 7.00% per annum. The actual position of LIBOR during the forthcoming reset period is as under: Reset Period LIBOR 1 9.00% 2 9.50% 3 10.00% You are required to show how far interest rate risk is hedged through Cap Option. For calculation, work out figures at each stage up to four decimal points and amount nearest to £. (7 Marks) (b) Expected returns on two stocks for particular market returns are given in the following table: Market Return Aggressive Defensive 7% 25% 4% 40% 9% 18% You are required to calculate: (a) The Betas of the two stocks. (b) Expected return of each stock, if the market return is equally likely to be 7% or 25%. (c) The Security Market Line (SML), if the risk free rate is 7.5% and market return is equally likely to be 7% or 25%. (d) The Alphas of the two stocks. (7 Marks) (a) XYZ Limited borrows £ 15 Million of six months LIBOR + 10.00 % for a period of 24 months. The company anticipates a rise in LIBOR, hence it proposes to buy a Cap Option from its Bankers at the strike rate of 8.00%. The lump sum premium is 1.00% for the entire reset periods and the fixed rate of interest is 7.00% per annum. The actual position of LIBOR during the forthcoming reset period is as under: Reset Period LIBOR 1 9.00% 2 9.50% 3 10.00% You are required to show how far interest rate risk is hedged through Cap Option. For calculation, work out figures at each stage up to four decimal points and amount nearest to £. (7 Marks) (b) Expected returns on two stocks for particular market returns are given in the following table: Market Return Aggressive Defensive 7% 25% 4% 40% 9% 18% You are required to calculate: (a) The Betas of the two stocks. (b) Expected return of each stock, if the market return is equally likely to be 7% or 25%. (c) The Security Market Line (SML), if the risk free rate is 7.5% and market return is equally likely to be 7% or 25%. (d) The Alphas of the two stocks. (7 Marks)

Answer rating: 100% (QA)

Solution a Interest Rate Risk Hedging through Cap Option The company XYZ Limited has borrowed 15 million for a period of 24 months at a fixed interest rate of 1000 per annum The company anticipates a ... View the full answer