INI CASE STUDY AND PROBLEM SOLVING ON HEGDING AND FINANCIAL ENGINEERING PRODUCTS. INDIVIDUAL ACTIVITY. ANSWER ALL THE QUESTIONS BELOW. TOTAL MARKS-30. 1. Compute the Value-at-Risk (VaR) of a six-month forward contract. The transaction requires the investor to deliver $12.7 million in 180 days and receive 10 million in exchange. Assume that the current spot rate is $1.26/1 and the annualized interest rate is 4% on a six-month zero coupon bond and 3% on a six-month zero coupon Euro bond. Again, assume the variance/co-variance matrix (on daily returns) across those instruments are as follows: Six-Month $ Bond Six-Month $ Bond Six-Month $ Bond

Six-Month $ Bond 0.0000314

Six-Month Bond 0.0000043 0.0000260

Spot $/ Rates 0.0000012 0.0000013 0.0000032

Compute the value of the short position in the zero coupon dollar bond. (2 Marks) Compute the value of the long position in the zero coupon euro bond (in $ terms), holding spot rate fixed. (2 Marks) (c) Compute the VaR for this forward Contract. (2 Marks) (d) Compute the daily VaR for this forward contract assuming returns are normally distributed with a 90% confidential interval. (4 Marks). Consider the table below. Fill-in the blank spaces with the reaction of the puts and calls to an increase in the variables in the left-hand column. (5 Marks) Increase in Put Call

Interest rate

Share Price

Volatility

Exercise Price

Time-to-Maturity

Assume all Assets on the ABC Bank Balance Sheet as at 2018 are risk weighted. (GHs) Current Assets 7,000,000.00 Current Liabilities 6,000,000.00

Long Term Assets 3,000,000.00 Long Term Liabilities 2,000,000.00

Owners Equity: Shares sold 800,000.00 Undisclosed Revaluation 800,000.00 Buildings 400,000.00

Total Assets 10,000,000.00 Total Assets 10,000,000.00

Compute the Risk-Weighted-Capital Ratio (2 Marks) Compute Liquidity Cover Ratio (LCR) (2 Marks) Compute the Leverage Ratio (2 Marks) Compute the working Capital (2 Marks) Compute the Capital Asset Ratio (CAR) (2 Marks) 4. An Australia based company takes a US$1 million variable rate loan in the United Kingdom at LIBOR + 2%. Identify the risks on this financial transaction (derivative) (1.5 Marks) Identify possible ways to manage the associated risk. (1.5 Marks) Describe ways to hedge FX risk only (1 Mark) Describe ways to hedge both IRR and FX risks. ( 1 Mark)

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