Ch 33: Derivatives for Managing Financial Risk

CHAPTER 33
Derivatives for Managing Financial Risk

Problem 1

Selling quantity of gold (ounce) 3,000

Future contract:
Future contract price 342 342 342
Spot price in the future 360 340 320
Profit/loss -18 2 22
Total profit/loss -54,000 6,000 66,000

Put option:
Exercise price 340 340 340
Spot (future) price 360 340 320
Pay-off 0 0 20
Less: option premium 3 3 3
Net payoff -3 -3 17
Total pay-off -9,000 -9,000 51,000

Problem 2

Wheat to be purchased (quintals) 100

Future contract:
Future contract price (assumed) 7400 7400 7400
Spot (future) price 7000 7500 8000
Profit/loss -400 100 600
Total profit/loss -40,000 10,000 60,000

Future price (assumed) 8000 8000 8000

Spot (future) price 7000 7500 8000
Profit/loss -1000 -500 0
Total profit/loss -100,000 -50,000 0

Problem 3

$
Future wheat price (3-mnth contract) 3.40
Spot price 3.00
Risk-free rate (annual) 12%
Risk-free rate (quarterly) 3%
PV of storage cost 0.43
PV of wheat 3.30
PV of convenience yield 0.13

Problem 4

3-mnth future index 5,686.40

Dividend yield (annual) 1.40%
Dividend yield (quarterly) 0.35%
Interest rate (annual) 8%
Interest rate (annual) 2%
Spot index 5,594.41
I. M. Pandey, Financial Management, 9th Edition, New Delhi: Vikas.

Problem 5

X Y
Rating AAA BBB
Borrowing rate - fixed loan 11% 14%
Borrowing rate - floating loan LIBOR + 0.3 LIBOR + 1.5%
Assumed notional borrowing amount (Rs million) 100 100
Assumed LIBOR rate 10% 10.50% 11%

Company X
Floating rate (LIBOR + 0.3%) 10.3% 10.8% 11.3%
Fixed rate 11% 11% 11%

SWAP payment 10.3 10.8 11.3

SWAP receipt 11 11 11
Net cash flow on SWAP 0.7 0.2 -0.3

Floating rate interest 10.3 10.8 11.3

Net cash flow on SWAP 0.7 0.2 -0.3
Net payment 11 11 11

Company Y
Floating rate (LIBOR + 1.5%) 11.5% 12.0% 12.5%
Fixed rate 14% 14% 14%

SWAP payment 11.5 12 12.5

SWAP receipt 14 14 14
Net cash flow on SWAP 2.5 2 1.5

Floating rate interest 11.5 12 12.5

Net cash flow on SWAP 2.5 2 1.5
Net payment 14 14 14

Problem 6

P Q
5-year dollar loan rate 9% 11%
5-year Euro loan rate 7% 8%
Assumed notional loan amount ($ million) 120 120
Dollar-to-Euro exchange rate 1.2 1.2
Assumed notional loan amount (Euro million) 100 100

Company P
Year Currency $ loan Swap $/Euro Euro cash flows
0 $ 120 -120 0
Euro 100 100
1 $ -10.8 10.8 0
Euro 7 7
2 $ -10.8 10.8 0
Euro 7 7
3 $ -10.8 10.8 0
Euro 7 7
4 $ -10.8 10.8 0
Euro 7 7
5 $ -130.8 130.8 0
Euro 107 107
Ch 33: Derivatives for Managing Financial Risk

Company Q

Year Currency $ loan Swap $/Euro Euro cash flows

0 $ 120 -120 0
Euro 100 100
1 $ -13.2 13.2 0
Euro 8 8
2 $ -13.2 13.2 0
Euro 8 8
3 $ -13.2 13.2 0
Euro 8 8
4 $ -13.2 13.2 0
Euro 8 8
5 $ -133.2 133.2 0
Euro 108 108