Treasury Management Exam question
Attached sample exam question & solutions.
This exam consists of 5 calculation questions worth 7 marks. However, I only have 2 hours to complete. Will be on Singapore timing: 7pm. I need you to send me back with your screenshot calculation answer.
Please let me know are you able to do it?
BUS288 Treasury Management
Practice Exam Questions – Solutions
1.
It is June 2nd 2010 and Paula has a diversified portfolio of shares (with a of 1) currently
worth $482,000. Although she believes the stock market will ease throughout July, she does
not wish to liquidate this portfolio, but rather to hedge its value using SPI200 futures contracts.
Currently, the ASX200 index stands at 4820 while the July 2010 and August 2010 SPI200
contracts are trading for 4830 and 4836 respectively.
i) What futures position should Paula take today in order to protect (hedge) her
investment?
ii) If on July 31st the ASX200 index is 4370 and August SPI200 contracts are trading at
4380, calculate Paula’s profit or loss on the FUTURES position you outlined in part
(i)
iii) What is the dollar value of Paula’s combined investments on July 31st?
[Recall that SPI futures are valued at $25 times the index.]
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2. Use a labelled diagram to explain why the value of a call option with an exercise price of
$21.00 and an expiry date of September 2010 is lower than a call option on the same share
with:
i) the same exercise price but December 2010 expiry date.
ii) the same expiry date but $20.00 exercise price.
iii) Refer to your diagram to complete the table for the $21 options.
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3. In June 2010, a bank will issue a 6/9 FRA referenced to BBSW with a guaranteed rate of 4.5%
p.a.. Bank bill futures for December 2010 delivery are priced at 95.25. Assume there are no
transaction costs and no spread between FRA borrowing and lending rates, and 30-day
months.
a) Identify a strategy based on one futures contract which will yield an arbitrage profit, and
b) If the 90-day bank bill rate turns out to be 6.0% in December 2010, calculate the gain or
loss on:
i) the futures position
ii) the FRA position
iii) overall.
[Note any assumptions you consider necessary.]
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4. It is June, and Marcus will need to borrow $10,000,000 for 90-days in September. If today’s
yield on 90-day bank bills is 6.5% and contracts for September and December exercise are
quoted at 94.25 and 94.35 respectively, and he believes that interest rates will only ease to
6.0% by September.
i) What futures position should Marcus take to hedge this exposure?
If in September, the September and December futures prices were 96.30 and 96.20
respectively,
ii) What profit (loss) would Marcus realize on this futures position?
iii) If Marcus issues commercial paper with a face value of $10 million in September, what
will be his net proceeds from the hedged position?
[Note any assumptions you consider necessary.]
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5. Exactly three years ago, Judy bought 8-year floating rate notes with a face value of $5 million,
and coupon rate of libor +3% p.a. paid semi-annually. To pay for this purchase, she borrowed
$5 million at the fixed rate of 8.5% p.a.
Five-year plain vanilla swaps are available with a mid-rate of 7.9% p.a. paid against LIBOR.
The swap dealer pays 10 basis points less than the mid rate and receives 10 basis points more.
i) Construct a diagram of an on-market plain vanilla swap which will remove Judy’s
interest rate risk.
ii) Describe the net dollar (initial, ongoing and final) exchanges between Judy and the
swap provider.
iii) What is Judy’s locked-in spread?
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6. A three-year bond has a face value of $1,000 and pays annual coupons at the rate of 8% p.a.
If market interest rates are 6% p.a., calculate its duration.
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7. It is now March 2010, and Mavis believes that in April 2010 an outbreak of ovis flu, which
causes baldness in sheep, will decrease the supply of wool and cause wool futures prices to
increase by 25%. The following wool futures contracts are available at the indicated prices:
Delivery date Contract price
March 2010 700 c/kg
June 2010 710 c/kg
September 2010 720 c/kg
If Mavis speculates by trading in four contracts (4 x 2,500 kg) of wool, clearly state what
futures position she should take. What should she do to close this position in May 2010, and
what profit she would realise if her expectation was exactly correct?
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8. A three-year bond with a face value of $1,000 pays interest annually with a 5% coupon rate.
What will be its current market price if 12-month interest rates for the next three years are
expected to be 5%, 5.5%, and 6.4% respectively?
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9. Jane Hedges has today invested in a 180-day bank bill with a face value of $1 million, priced
to yield 6.30 per cent per annum. Simultaneously she has sold a futures contract on a 90-day
bank bill with a face value of $1 million. The futures contract will expire in 90 days’ time
from today. The futures price is 93.55. Jane intends to settle the futures contract by delivery.
Ignoring any effects from the mark-to-market rule, determine the amount and timing of Jane’s
cash payments and receipts and calculate the yield (simple interest, in per cent per annum) she
will achieve on her investment? What if anything, does this imply about today’s 90-day bank
bill yield?
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10. In June 2011, a sheep farmer became concerned that by the time her 50,000 kg wool crop was
ready for delivery in November 2011 that the price would fall from its current $10.50 per kg
to less than her $9.60 per kg break-even price. One wool contract is for 2,500 kg, and June,
September and December wool futures prices are $10.45, $9.90 and $10.20 respectively.
Show how the farmer can ‘lock in’ a profit for her business by entering and subsequently
reversing a futures market position, if in November, the spot and December futures prices fell
to $9.50 per kg and $9.40 per kg respectively.
11. In the context of question 10, explain what is meant by the terms ‘price risk’ and ‘basis rate
risk’.
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12. On June 6th 2011, Alfred was advised by his bank that his application for a bill acceptance
facility that would allow him to issue 120-day bank bills with a total face value of $750,000
in December 2011, was successful. These will be sold to yield BBSW+0.5% p.a. Concerned
that interest rates may rise before the bills are issued on December 6th, Alfred assembled the
following FRA quotations payable against the reference rate of BBSW.
FRA Lender Borrower
6/9 6.5% p.a. 7.5% p.a.
6/10 6.6% p.a. 7.6% p.a.
9/12 6.9% p.a. 7.9% p.a.
10/13 7.0% p.a. 8.0% p.a.
Clearly state how Alfred should use an FRA to hedge his exposure, and calculate the amount,
direction, and date of the payment at settlement if, on the settlement date BBSW is 6.1% p.a.
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13. The dealer’s mid rate for a four year plain vanilla swap is 7.55% against AUD LIBOR. The swap
dealer pays 10 basis points less than the mid rate and receives 10 basis points more. Construct a five
year plain vanilla interest rate swap which will remove the interest rate risk of Ernie Ltd and Bert
Ltd who are in the following position:
Income Liability
Ernie Ltd: AUD 10 million AUD 10 million
@AUD libor+2.5% @ 7.0% p.a.
Bert Ltd: AUD 10 million AUD 10 million
@ 9% p.a. @ AUD libor-0.5%
Diagram all interest flows, determine the lowest effective borrowing cost for each, and their
locked-in spreads.
14. Explain how interest rate swaps are able to reduce financing costs. Provide an example.
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15. The bank bill futures price for settling in 180 days is fixed at 93.75. A bank will issue a
180/270 FRA referenced to BBSW with a guaranteed rate of 6% pa. Assume that there is no
spread
between the FRA borrowing and lending rates. Identify a strategy which will yield an
arbitrage profit, and demonstrate how this will be achieved if the 90 day bank bill rate turns
out to be 8% in 180 days time.
16. With reference to share price index futures, explain what is meant by the term ‘hedge ratio’.
Why is it important for constructing a hedge for a portfolio of shares, and what are the
limitations to it providing a perfect hedge?
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17. Gill buys 1,000 BHP shares at a price of $28.00 and decides to construct a hedge by writing
an equal number of call options, with an exercise price of $27.00 and a premium of $1.40 per
option. Ignoring the time difference between the purchase of the option and its expiry:
i) construct a clearly labelled diagram showing the expiry profit as a function of share-
price, from the hedged position.
ii) calculate the profit for the expiry share-prices of $26.00 and $30.00.
18. Identify the 5 factors which impact the value of a put option. Indicate whether an increase in
the value of each will increase or decrease the value of the put option.
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19. Harold intends to borrow $10 million for 12 months, in three months time. He is able to
borrow with quarterly interest payments and resets at BBSW +0.5% p.a., but fears that rising
interest rates will increase his borrowing costs. A 12-month interest rate cap with a strike rate
of 6.5% p.a. and referenced to BBSW commencing in three months, is available for the
premium of 0.15% p.a. Determine the amount, direction and timing of the payments that will
be made under the combination of the loan and cap if the BBSW in 3, 6, 9 and 12 months is
respectively 5.9%, 6.4%, 7.2% and 8.0% p.a. (Assume 90 day quarters and a 360 day year.)
20. Identify the 5 factors which impact the value of a call option. Indicate whether an increase in
the value of each will increase or decrease the value of the call option.
21. What is “put – call parity”?
22. Calculate the price of a 2-year, 8% p.a. semi-annual coupon bond with a face value of $1000
if interest rates are 6% p.a. and show that its duration is 1.89 years
t CF DCF txDCF
1 40 38.83495 38.83495
2 40 37.70384 75.40767
3 40 36.60567 109.817
4 1040 924.0265 3696.106
1037.171 3920.166
Duration: 3.779672 periods
1.889836 years
Bond price = $1037.
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23. Twelve month interest rates for the next three years are expected to be 6%, 6.5%, and 7.4%
respectively. Show that the yields to maturity on:
i) a pure discount three year bond, and
ii) a three year 6% annual coupon bond
are 6.632% and 6.605% respectively.
24. Discuss the following statement:
“Early cash flows are worth more than later cash flows, so European put options with shorter
maturities are worth more than those with longer maturities, other things equal.”
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25. a) The bank bill futures price for settling in 180 days is 93.75. A bank will issue a 180/270 FRA
referenced to BBSW with a guaranteed rate of 6.5% pa. Assume that there is no spread
between the FRA borrowing and lending rates. Identify a strategy which will yield an
arbitrage profit, and demonstrate how this will be achieved if the 90 day bank bill rate turns
out to be 9% in 180 days time.
b) With reference to part (a), explain how the presence of an arbitrage opportunity will lead to
the enforcement of the ‘Law of One Price’.
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